What is the value of Fed chairman Ben Bernanke’s word? Last week, the markets tumbled after his remarks about the possibility of a slow withdrawal of the Federal Reserve’s bond-buying programme. Just in the United States, stocks lost around a half of a trillion dollars (381 billion euros), according to Barron’s. The capitalisation of the London Stock Exchange went down by around 100 billion euros.
So, Ben Bernake’s word is very worthy. More than one trillion dollars, which is what stocks plus commodities plus fixed income have lost since he just mentioned the possibility of a gradual tampering of the monetary stimuli if the economy accelerates its rate of expansion and job creation.
Or isn’t it?
Maybe Ben Bernanke is just bluffing, and neither he nor his peers at the FOMC are planning to tap the liquidity faucet that have been kept opened since, basically, 2008.
This is not wishful thinking. Conventional wisdom says that in the second half of the year, the US economy will pick up steam. But, where is that steam coming from? After its precipitous fall in January, disposable income is stagnated; exports are growing but, with the EU economy in or around zero growth and China slowing down, it is difficult to see foreign sales as a growth engine; government spending is being slashed; corporate profits are growing tepidly; and investment remains stable.
To make things worse, Bernanke’s words have strengthened the headwinds of the US economy. Real interest rates are up by one point compared to oner year ago, and the dollar is rising, curbing exports, slowing the recovery of the housing market and making difficult the de-leveraging of firms and families.
There is another point of contention–why should a central bank limit liquidity when the economy is not too far from failing into deflation? Even further–why should that be done by Bernanke, an expert in the Japanese crisis of the Nineties?
The last argument is that the Federal Reserve has a terrible track record in forecasting growth. In 2009, it predicted 4.2 percent growth in 2011; it ended up in 2.4 percent. In 2010, foresaw 3.5 percent in 2012. The final figure was 2 percent.
Surely, Ben Bernanke is aware of all this. So, what is he doing? Maybe just bluffing. In that case, the word of the chairman of the Federal Reserve is worthless.
Bernanke could be preparing the ground for an actual withdrawal of the monetary stimulus. But, in order to do that, he must put some rationality in the market. Now, US house prices are experiencing two-digit growth rates; junk bonds are almost undistinguishable from triple-A assets; and structured products, similar to the same ones that caused the mortgage hecatomb of 2007 and 2008 are coming back. That suggests a lot of froth in the market and, in such situation, reducing liquidity could be risky.
So the Federal Reserve may be playing with expectations. An acute aficionado to economic history, Ben Bernanke has two examples of what to avoid, both by his mentor, Alan Greenspan. In 1996, Greenspan famously complained about the “irrational exuberance” in the stock market, but did not raise interest rates. As a result, the dotcom bubble started and, when the Fed finally took action, the market crashed and the US and world economy fall into recession. In 2006, the Fed started to very gradually increase the interest rates again, only to provoke panic and the worst crisis since the thirties.
Maybe this time Bernanke is just trying to provoke a mini-crash to lay the foundations for a progressive withdrawal of the monetary stimulus in 2014 or, maybe, 2015. According to that thesis, he could be trying to lower the market expectations so, when liquidity is finally drained out, many of the current excessive risks will have been eliminated.
If that is the case, Bernanke is raising the stakes with his bluff. It is, however, a risky bluff. Only the future will tell if this is the Fed’s strategy and, in that case, if it works. But there is something clear–the current economic conditions of the US economy do not support the thesis of a rapid acceleration of growth.