Ben Bernanke's Fed: An Unbalancing Act?

On Wednesday, the Federal Open Market Committee left monetary policy unchanged. As they have done for months, Chairman Ben Bernanke and other Fed policymakers announced that the risks to the U.S. economy were balanced. Once again, they indicated that they would reconsider their stance as additional data dictates.

Unfortunately, while investors seemed to applaud the policymakers' lack of action, the truth is that the central bank's seemingly measured approach since Ben Bernanke's tenure began has had numerous unintended -- and unwelcome -- consequences. In my view, the Fed has:

• Encouraged bad behavior. By reassuring everyone that the economy remains in a holding pattern, policymakers have inspired investors to carry on as before: piling on leverage, taking excessive risks, and failing to prepare for the inevitable negative turn in credit, economic, and risk cycles.
• Fostered misperceptions about risk. Policymakers' continuing assertions that economic and inflation threats have more or less equal weight has engendered the illusion, in some quarters at least, that these two risks somehow cancel each other out, when it is the growing overall risk exposure that should matter most.
• Pointed investors in the wrong direction. The balance of recent economic data, including today's report on April retail sales, suggests that recession, rather than inflation, is the greater near term threat, but policymakers' have nonetheless managed to keep markets focused on the latter. As a consequence, investors have taken inappropriate actions that will come back to haunt them once the Fed acknowledges reality.
• Undermined policymaking effectiveness. In adopting what appears to be a reactive rather than proactive stance, the Fed has relinquished its leadership role, essentially leaving hedge funds, politicians, and foreign nations in charge of U.S. monetary policy.
• Laid the groundwork for future instability. With monetary policy being increasingly data-dependent, the risk is that policymakers will find themselves behind the curve at the worst possible moment. That boosts the odds that they will either under or overreact to a change in circumstances, or they will be totally blindsided by unforeseen events.

Despite what appears to be an unsually good start, Mr. Bernanke's next year on the job may not be so fortuitious.

(P.S. The Wall Street Journal's MarketBeat Blog earlier noted some of my views on the subject in "Laissez-Faire Fed?")

Comments

[Dmitry]

Nevertheless, I believe the article in the WSJ MarketBeat blog managed to completely misinterpret your position, at least the way I understand it -- by trivializing it and force-fitting it into the Procrustean bed of the all-encompassing debate between "FED must raise" vs. "FED must lower" camps. The conclusion that the author of the commentary David Gaffen arrives at is as typical just as much as it is telling:

"That commentators could be so
critical of the Fed — and yet
arrive at vastly differing
conclusions — perhaps suggests
the default, the muddled middle,
might be the right place after all.

In other words, the risks on both sides are evenly balanced. "The muddled middle" of stable 5.25% Fed Fund rate is just what this economy needs. The "great debate" about this economy's ailments and imbalances, strengths and weaknesses, past and future, causes and effects, boils down to one number at the shortest end of the yield curve.

The image of a mad doctor who attempts to "treat" a patient with frost-bitten feet by pouring boiling water on his head (in order to maintain the average temperature of the patient's body within "the muddled middle" range) did cross my mind as I read David Gaffen's blog post.

[Brian]

What the lumpen masses in America need to understand here is that this whole thing (markets, wealth, CNN, Martha Stewart, Paris Hilton) heck, even life itself, is one huge freaking side show at a giant fair ground. Everyone in the side show has a roll to play. From the hucksters, scammers, and con artists all the way up to the do-gooders, that’s their roll to play.

The vast majority are going to be told information and then react upon it. What a spectacle we live in. And each day the spectacle gets more grotesque, and then new opinions are formed about what they are witnessing and it becomes a “New” belief system, good for the day thinking takes over. Markets\Life\Events all promote these “New” opinions. The honest values, beliefs, and the very fabric that hold our lives together get tossed out like a used diaper. Life is moving so fast, and “New” opinions are forming so fast that when you voice your opinion you are ridiculed for thinking and even discussing the old stable, true and honest value systems of yesteryear that the country was founded on.

We have handed our lives over to Corporations. They control every aspect of it. Everything from feeding ourselves, right up to not being able to sleep at night. BTW, they have a solution for that also. But they won’t tell you they are the cause of you not sleeping at night to begin with. What madness!

I see more fools getting bamboozled everyday right inform of my eyes. Personal friends of mine that I would not dare discuss this stuff with because it’s not “Party Talk”. I’m told to keep my mouth closed tightly when out with the wife. Too much Doom and Gloom she says. No, I say. I’m merely making observations and telling you about it.

Here is a quick story on something I personally witnessed. When reading this keep the context of how people react to situations and the above comments.

A friend of mine accepted a 12 month severance package from their employer. They sat on their rear end for 12 months not looking for a job until the last month. Apparently this person thought they would be snapped up in a second and would have no problem finding a job. Well, it didn’t quite work out that way. Unemployment benefits were applied for, then denied, panic set in, the family went into spending lock down, mortgage and taxes were going up, finally benefits were paid (sigh of relief). There was utter panic in this person and the spouse; it was not pretty to watch. They even took a 100% commission paying job as desperation was ruling the day. The whining, complaining, panic was taking over. Bills had to be paid, kids had to be fed and clothed. They obviously lived beyond their means.

But then things changed luckily for them. The working spouse got a higher paying job; the wife was still getting an unemployment check so the stress cooled down a bit but not to previous levels. Eventually the other spouse did find a job paying close to what they were making before, and now all is well.

But now here is the really pathetic part in all this. Since things have turned around for the better, and realizing that this was a “Really Close Call”, and then tying to learn from this episode guess what the talk is now between the couple. A new bigger house for the family, a nice expensive vacation in an all inclusive resort, and the spending party is back in full throttle.

Now, I’m simply making observations here on how people swing from one extreme to the other on a dime. In instead of learning from this and realizing what could have been, they do quite the opposite and throw it in OD and plow on. This seems like utter madness to me. I hope for their sake the new job works out!

[Glen]

I enjoyed Brian's comments....also enjoyed Michael's comments as always.

I believe this economic disaster we live in is due to short-sightedness, selfishness, or whatever you want to call it. Ultimately living for today vs. tomorrow! Let tomorrow bring whatever Hell it brings as long as we wine and dine today!

My wife overheard a conversation at the local public library last night between a patron and the librarian; the gist of which was....the patron had saved for 3 or 4 years and had just bought a Hummer....the librarian was asking why the lady had bought it when gas prices were rising quickly.....the lady replied that she didn't care because she finally had her Hummer and if she waited any longer she would never get one.

Last night, on the evening news, they did a short piece on saving. They used an older couple as the role model. The couple raised all their children in a tiny house while scrimping and saving. They used their savings to put $40k down on a new home that (if I recall correctly) was over 6000 sq. ft. HELLO what in the world is smart about that. 1st - They bought at the height of the boom (at least in Utah). 2nd - There are just 2...I repeat 2 people living in a 6000 sq. ft. space. I don't care how many grandchildren they have. Unless they are all planning on living together at some point in time that is a waste of space i.e. economic resources. 3rd - What a waste of savings.....and now its all gone. They are counting on employer retirement plans and Social Security for their retirement....fat chance of that happening. Anyways it was a disgusting example of how we should be smart with our finances. The reason we are in this mess in the first place.

By the way, Michael, I just finished reading your book two nights ago. Very interesting reading. I had hoped for some clearer solutions or preparations but I reckon the reality is.....that its pretty tough to prepare for since no one really knows to what extent things will decline or implode.

I think the Mormon leaders have something with their guidance to stay out of debt as much as possible (the only OKs are a modest house and education) and to get a one years food supply (including water) along with some emergency cash on hand. Although, judging by the bankruptcy statistics for Utah.....no one listens.

I would probably add to that a 72 hour kit, shotgun for home defense, some education materials on medicine, medical treatment, and food sources. At the end of the day....A Plan....so your not running around like a chicken with your head cut off!

I've rambled enough. Take care and I appreciate everyone taking the time to share their opinions!

Mr Mike:

I spent the last day or two reading your book and i must say it was a great read!

A couple of questions:

1) Given the clouds on the financial horizon, would you be inclined to focus on saving outside of your 401k rather than locking money up?

2)Would you reccomend moving to another currency before things get really nasty? or at least setting up an account outside of the US?

3) Any harm in stocking up the safe deposit box with cash and gold now, or would they be "safe"

4) and finally in the 2 or 3 months since you published Financial Armageddon, are you more or less optomistic about these predictions and when this great unwind may occur

I realize we are all on our own in the end, but i would appreaciate your thoughts.

[Michael Panzner]

There are undoubtedly advantages to funding a 401(k) at present, especially if employers match some proportion of employees' contributions. But the risks to consider are: tax rates rise significantly in the medium-to-long term (until, that is, taxpayer revolt eventually forces them back down); the U.S. government takes action that impairs the status of those funds (e.g., forced conversion into government bonds); and, a longer-term collapse in the dollar (those who've read Financial Armageddon know that I have a view on the U.S. currency that is decidedly contrarian in the near term). The answers to the other questions can be found in my book and on this site.