Sunday, March 25, 2012

Bernanke "The Hero" Creates A New Mirage

Back in 1999, as the NASDAQ bubble was roaring higher, Robert Rubin, Larry Summers, and the Federal Reserve chairman at the time (Alan Greenspan) graced the cover of Time magazine with the headline "The Committee To Save The World.


After "rescuing" the American economy back in 2001 by lowering interest rates to 1% and flooding the country with cheap credit for consumers to purchase cars, trips, and homes, Greenspan received the name "The Maestro."


Just a few years later in 2008, after choking on the easy money debt Greenspan created, America entered into an economic depression and the financial system collapsed.


Since then we have followed the same prescription only this time the debt has been taken on by the federal government and it has been financed by Ben Bernanke with low interest rates and trillions in quantitative easing programs.  The sugar high of the debt and easy money stimulation has once again entered the economic bloodstream, and we have a feeling of euphoria last felt during the 2002 - 2007 consumer debt fueled boom. The Atlantic this week trotted out a cover with a smiling Ben Bernanke calling him "The Hero."


Bernanke has promised us low unemployment, economic growth, and inflation at 2% per year.  This can be done, he tells us, without suffering any pain from the debts incurred by both consumers and governments over the past 40 years. Greenspan, the Maestro, promised Americans the same thing after the stock market crash in 2000. Americans, politicians, and businesses believed him back then and shockingly most of them believe Bernanke today.

Even a young child can understand that this concept is ridiculous, but let's just say for a moment that this economic "miracle" can become reality. What does this desired 2% inflation that Bernanke wants so desperately to achieve look like?

2% inflation per year cuts the value of the dollar by 75% over a typical lifetime. That means if an American works hard, saves their money, and accumulates 1 million dollars for retirement they will find out that inflation has taken away 75% of their purchasing power.

Over a 35 year period, 2% inflation cuts the value of the dollar in half. Over another 35 year period it cuts the value of the dollar in half again. This is due to the magic of "compounding interest" that you may have heard about when the bank tells you to put money away at a young age.  This magic can be seen in the following chart.


What if Bernanke misses his target by just a small amount while he is working on getting unemployment lower with endless QE programs? What if inflation ends up running at 4% per year (it is already running close to that amount today based on government measures such as the CPI)?

At 4% inflation the value of the dollar will be cut in half in just 18 years. That means when your child is born and you begin saving for their education, when they reach high school graduation half of the purchasing power of that savings will have disappeared.

Bernanke tells us not to worry about this because all boats will rise together. If prices rise it must mean that wages will rise as well, right? Up until late 2007 (when America entered its current depression) wages tracked prices beautifully as can be seen in the chart below. Since then wages have fallen and stagnated sideways while the cost of living continues to rise.


The trillions pumped into the economy worked beautifully on making the price of gasoline, food, rent, and insurance rise, but wages have been falling (for anyone lucky enough to have a job).

The recovery, just as it was during the artificial credit fueled boom of 2002 - 2007, is a mirage. In 2008 the economy hit a wall when consumers as well as state and local governments could no longer borrow and spend.  Their debt still sits on the balance sheets, suffocating them more every day.

On top of that we now have a credit fueled explosion in federal debt and student loan debt, which have now crossed $15 trillion (federal debt) and $1 trillion (student loan debt). How will this be paid back?

It won't.  When the markets understand this Bernanke "The Hero" will become as vilified as Greenspan "The Maestro" was after his bubble burst. It takes no courage to keep interest rates at 0% and run endless QE programs promising no pain for anyone.


Back in the early 1980's, Federal Reserve chairman Paul Volker raised interest rates close to 20% to crush inflation and cleanse the economy of the toxic debt it had incurred. The country entered a deep recession during the period. He was hated by politicians, business owners, and Americans who were addicted to the easy credit. There were no covers of magazines proclaiming his courage, but he did what was best for the country and created the foundation for the greatest economic boom in history from 1980 to  2000.

As Bernanke tells us today that there is no danger in his funding of our deficits with printed money, it is important to remember what he was telling us back in 2005 to 2007, just months before the financial system collapsed.

No comments:

Post a Comment