Big Ben’s Mistakes

As soon as Bernanke starts his helicopter engines, bond buyers get out their guns; the Chinese - the biggest single customer for US debt - have warned that they will shoot him down. What can Bernanke do? He is damned if he doesn't. But even more damned if he does. He can't guarantee increases in either CPI or stocks. All he guarantees is that Big Government will play a larger role in the economy. Likely that Milton Friedman's history of the Great Depression will turn out to be a true prophecy: "The Fed was largely responsible for converting what might have been a garden-variety recession... into a major catastrophe..."

Eventually, Bernanke does what his predecessors at the Fed did in the '30s, and what the Japanese did in the '90s. He makes mistakes. He probably wonders why he took this damned job in the first place.

“Three more bank failures last week, making eighty-four for the year (compared to 25 in 2008, 3 in 2007), and four hundred and sixteen institutions now in the FDIC’s internal “problem list,” up from 305 at the end of the first quarter.” - The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the US Congress to maintain stability and public confidence in the US banking system.

According to the newswires, “many analysts now expect anywhere from 100 to 300 more bank failures before the crisis is fully ironed out.” it probably are many more. Consider that banks hold somewhere in the vicinity of $1.7 trillion of commercial mortgages and construction loans, widely considered the next “shoe to drop.” The default rate on commercial mortgages is up six-fold over the last year.

On the commercial mortgage backed security (CMBS) side, “over $150 billion worth of resets come due over the next two years. Deutsche Bank reckons about two thirds of that money will find refinancing very difficult, mostly due to continuing falling commercial real estate prices.”

When Ben Bernanke got the nod for another stint as head of the world's most important central bank, he completely misunderstood the implications of the hugely negative US trade balance, believing that America did the world a favor by spending its "global saving glut." He missed the right approach of the latest - meanwhile the biggest -financial disaster in 60 years. When it arrived, he mistook it for a routine recession, until finally, he panicked by the collapse of Lehman Bros. He insisted that Congress pass a $750 billion spending bill - or "we may not have an economy on Monday."

He was a professor of economics at Princeton and holds a Ph.D. from MIT - just like the most recent Nobel Prize winner in economics, Paul Krugman.

The United States has just averted the Second Great Depression say the papers. "What saved us?" asks Krugman in a recent New York Times editorial. "Big government," is his answer. Better Ben Bernanke’s big Government.

But the ghost of Milton Friedman haunts the central bank. Bernanke borrowed a phrase from Friedman, saying he'd even "drop money from helicopters,' if necessary, to prevent deflation.

"Inflation is always and everywhere a monetary phenomenon," said Friedman. “But deflation doesn't seem to be a monetary phenomenon at all.” Despite huge inputs of new money from the Fed, prices are still going down. The Fed's balance sheet more than doubled in the last 18 months. It will probably double again - to $4 trillion - before Bernanke's next term is over.

Friedman's work itself was flawed in the same way. The general principle was correct - that the government that governs the markets least governs best. But when he got into the mechanics of 'monetarism,' he got lost. He believed that if the Fed kept its eye on the money supply; the free market would take care of everything else. But the free market didn't take care of everything, at least not as people hoped. Economist Murray Rothbard explained why in 1971. “You cannot expect the free market to function perfectly if you leave in the hands of the government the power to control money. Either markets are free or they aren't, was Rothbard's point. If they're not free, you can't blame freedom when they fail.”

Writing in the Washington Post, Nobel Prize-winning economist Joseph Stiglitz says “America’s massive deficit means a new global reserve system is approaching.”

“The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback's role as a reliable store of value around the world. At present, with so much unused capacity in the economy and so much unemployment – likely to persist for at least another year or two – the more pressing worry is deflation - a general decrease in prices - not inflation. But as the economy eventually recovers, the possibility of inflation will loom, and with forward-looking markets, worries about the future often play out in the present. Anxieties about future (hyper) inflation can lead to a weaker dollar today.”

Bad decisions have to be corrected: hopefully many people will read this important simply explained lesson and understand that all of us are victim of incapable but powerful executives in government. It's a shame, that with modern knowledge, experience and development such can happen, that otherwise could have been avoided. Count with another Great Depression like the one of the 1930s, or even worse this time. People only learn from their mistakes, when it is too late. For the next (3rd) Great Depression a couple of generations down the road do realize that similar mistakes will be committed again. Let that be known to future generation as a continuing red warning light!