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 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 18-Aug-07
Ben Bernanke's Great Historic Experiment

Web Log - August, 2007

Ben Bernanke's Great Historic Experiment

Bernanke doesn't believe that bubbles exist. His Fed policy will now test his core beliefs.

The story goes that when Fed Chairman Ben Bernanke was a little boy in the 1960s, he asked his grandmother why kids didn't wear shoes during the Great Depression. "Because they didn't have any money to buy shoes," she said. Why didn't they have any money? "Because the place they were working had closed down." Where had they been working? "A shoe factory."

This made no sense to Bernanke. If someone just gave a little money to the shoe factory owners, then they could have opened the shoe factory, manufactured some shoes, sold them, and paid the workers, who could then buy shoes for their children. All it would take is a little money.

That's why Bernanke doesn't believe in bubbles. That's why he believes that the 1930s Great Depression was CAUSED by the Fed -- which could have poured some money into the economy and prevented the Great Depression completely.

Bernanke undoubtedly knows that he and the Fed are being tested right now. He must know that the liquidity crisis going on right now is very similar to the liquidity crisis that preceded the 1929 crash.

If his theory is correct, then the actions he's pursuing now will prevent a new Great Depression.

And so, the Fed and other central banks around the world have been pumping money into the financial institutions of their various countries.

Related Articles

Understanding deflation: Why there's less money in the world today than a month ago.: As the markets continue to fall, the Fed is increasingly in a big bind.... (10-Sep-07)
Alan Greenspan predicts the panic and crash of 2007: He's said this kind of thing before, but this time it's resonating.... (08-Sep-07)
Bernanke's historic experiment takes center stage: An assessment of where we are and where we're going.... (27-Aug-07)
How to compute the "real value" of the stock market. : And some additional speculations about stock market crashes. (20-Aug-2007)
Ben Bernanke's Great Historic Experiment: Bernanke doesn't believe that bubbles exist. His Fed policy will now test his core beliefs.... (18-Aug-07)
Redemptions of money market funds now fully in doubt: Wednesday is the deadline for 3Q redemption of many hedge fund shares.... (15-Aug-07)
Alan Greenspan defends his Fed policies, as people blame him for the subprime crisis: Greenspan never ceases to amaze, and he did so again on Monday.... (8-Aug-07)
Nouriel Roubini says: "Worry about systemic risk." Whoo hoo!: His arguments show what's wrong with mainstream macroeconomics.... (6-Aug-07)
Robert Shiller compares stock market to 1929: He says the recent fall was caused by "market psychology," but is puzzled why.... (20-Mar-07)
A conundrum: How increases in 'risk aversion' lead to higher stock prices: Maybe because the global financial markets are increasingly "accident-prone."... (12-Mar-07)
Pundits are suddenly talking about (gasp!) "risk aversion": Fearing full-scale panic in the mortgage loan marketplace,... (6-Mar-07)
Alan Greenspan blames the housing bubble on the fall of the Berlin Wall: Meanwhile, the stock market keeps skyrocketing and appears unstoppable to many investors.... (25-Oct-06)
System Dynamics and the Failure of Macroeconomics Theory : Mainstream macroeconomic theory, invented by Maynard Keynes in the 1930s, has failed to predict or explain anything that's happened since the bubble started, including the bubble itself. We need a new "Dynamic Macroeconomics" theory. (25-Oct-2006)
Alan Greenspan gives another harsh doom and gloom speech: Saying that "the consequences for the U.S. economy of doing nothing could be severe,"... (4-Dec-05)
Ben S. Bernanke: The man without agony : Bernanke and Greenspan are as different as night and day, despite what the pundits say. (29-Oct-2005)
Fed Chairman Alan Greenspan says that the deficit is out of control: France's Finance Minister Thierry Breton quoted Greenspan... (25-Sep-05)
Fed Governor Ben Bernanke blames America's sky-high public debt on other nations: I'm normally wary of applying specific generational archetypes to individuals, but Bernanke is acting like a Baby Boomer.... (14-Mar-05)
Greenspan's testimony further repudiates his earlier stock bubble reasoning: The Fed Chairman has now completely reversed his previous position on the stock market bubble... (17-Feb-05)
Alan Greenspan warns that global economic dangers are without historical precedent : In a speech on Friday, Greenspan buried a major change of position in a speech admitting that his assumptions about the economy for the last decade were wrong. (6-Feb-2005)

But Bernanke's biggest shot so far occurred early on Friday morning.

Wall Street was set to open sharply down. The Tokyo Stock Exchange had fallen 6% the previous night, and it looked like the Dow would fall 100-200 points when the markets opened at 9:30 am. That would be the seventh straight day of losses, at a time when the Fed was already pumping money out into credit markets.

Bernanke took the next step. Early Friday morning, the Fed lowered the discount rate from 6.25% to 5.75%.

Now, let's explain. Financial institutions are permitted to borrow money from the Fed when they're in trouble, and they can do so if they're willing to pay the discount interest rate. By lowering the discount rate, the Fed presumably makes it cheaper and easier for banks and so forth to borrow money if they need it.

The Fed discount rate is not the same as the Fed funds rate, which is the rate that everyone watches closely. That one has been at 5.25% for some time, and was close to zero just a few years ago. The Fed funds rate controls interest rates on Treasury bonds, and so affects everyone. The discount rate is much more restricted, and it's a higher interest rate. Banks usually just borrow money from each other at the funds rate (5.25%), but if they're stuck, they can borrow from the Fed's "discount window," now at 5.75%.

So, the Fed took a fairly modest step in the direction of making more money available.

Well, the results were spectacular. Instead of going down, which had been expected, the Dow shot up 300 points in just the first few minutes of trading. There were some oscillations, but the Dow ended up 200 points or so by the end of the day.

So, does this prove that Bernanke's theory is right? Just lower the discount rate, and investors immediately give up their risk aversion and go back to pumping up the stock market bubble?

This I have to see.

We can expect the market to fall sharply again as soon as there's bad news.

What's wrong with Bernanke's "shoe factory" story?

When Bernanke was a kid in the 1960s, all the country's leaders were from the generations that had beaten the Depression and had beaten the Nazis. They survived by learning how to manage money and learning how to govern. There were popular books around with titles like "Think and Grow Rich" and "How to get rich in real estate." It was a "can-do" time.

At that time, if you gave money to an entrepreneur, he would indeed start a business, whether it be a shoe factory or a computer factory. The company's financials would be carefully monitored, and a successful businessman could convince the bank to lend him more money to build his business, if it was well-managed.

So Bernanke's solution would have made sense in the 1960s.

But that shoe factory solution would not have worked in the 1930s.

The leaders in the 1930s were very similar to the leaders today, who are from the Boomer generation and Generation-X. People from these generations have no idea how to govern -- as can be seen from the clown circus going on in Congress -- they have no idea how to manage money -- as can be seen from debauched use of credit in the last few years -- and they have no idea how to run a business -- as we can see from the way that manufacturing jobs have fled to China and service jobs have fled to India.

1930s leaders were just as incompetent as leaders are today. Injecting money into the economy then would have been as ineffective as doing it today.

Does anyone really believe that lowering the discount rate by % will make any difference? Will that help anyone start a shoe factory?

Last year I wrote an article entitled "System Dynamics and the Failure of Macroeconomics Theory." That article explained what's wrong with mainstream macroeconomics, and why it had failed to explain or predict anything since the dot-com bubble began in 1995.

Mainstream macroeconomics is wrong because it assumes that people's economic attitudes and behavior are correlated to their income, their social class, and their age. So, according to their models, a white 50-year-old upper class male today would be very similar to a white 50-year-old upper class male in 1975.

But that's simply not true, as this web site has been showing for years. The mainstream models assume that when someone becomes poor he changes his behavior, but that's absurd. Income, social class and age are MUCH LESS important than the generation you're born in.

A white 50-year-old upper class male today would be very similar to a 20-year-old upper class male in 1975. That's what mainstream economists can't seem to get through their heads.

They can't understand the simplest things. Today's population is VASTLY different from the population even ten years ago, for a very simple reason: Ten years ago, there were still quite a few people around who had lived through and survived the Great Depression. Today there are almost none, and that makes all the difference in the world.

If you look at the various economics blogs these days, you'll see discussions of the concept of "moral hazard." This is the most ridiculous discussion imaginable, and shows how out of touch economists and financiers are with what's going on in the world.

The "moral hazard" concept is that if the Fed lowers interest rates to bail out people and institutions that have behaved badly, then you're essentially rewarding bad behavior, and the people and institutions will continue their bad behavior.

So let's see: People in the incompetent Boomer generation have created the dot-com bubble, the credit bubble, the housing bubble, and the stock market bubble, they signed millions of subprime mortgages that will cause them to lose their homes, and they created tens or hundreds of trillions of dollars worth of collateralized debt obligations (CDOs) whose tentacles have reached into the financial portfolios of most institutions around the world.

After all that, the economists are all sitting around worrying about whether a % decrease in the Fed discount rate will cause Boomers to exhibit bad behavior. That's like worrying about whether a serial mass murderer is going to get a parking ticket.

And so, another day has gone by where we've seen that these so-called "experts" have ABSOLUTELY NO IDEA what's going on. The only way you can understand what's going on is to understand generational theory, and they won't even consider that. They'd rather stick to their models that are always wrong.

And so, Ben Bernanke's Great Historic Experiment will go on.

I wonder where he is tonight? Is he in bed, sleeping soundly, confident that the global economy is in good shape, thanks to his % decrease in the Fed discount rate, and that he will prove, once and for all, that he's conquered the economic cycle, and that he'll be recognized by historians as a hero?

Or is he tossing and turning, worrying about what's going to happen tomorrow and the day after and the day after that? Is he worried that, perhaps, history will recognize him as one of its greatest failures?

I'd bet that he's tossing and turning, because he knows what we all know: He doesn't have the vaguest idea what's going on. (18-Aug-07) Permanent Link
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