Steve Blitz Morning Notes

The article is on Bloomberg this morning and the opening paragraph says a lot about the problem with the debate. Bernanke sounds like the guy who lets his partygoers get drunk, drive home, and then wants credit for the rescue effort after the inevitable pileup --

Federal Reserve Chairman Ben S. Bernanke will defend his unprecedented actions to prevent a financial collapse as debate on whether he should be reappointed begins.

We did have a financial collapse and we got there because of his two major failings --

1. Bernanke's focus on inflation targetting instead of credit growth (still is, by the way)-- even though domestic inflation in a rising trade deficit economy with a strong currency propped up by the trade surplus country means little. Capital inflows impacting interest rates mean more. Too much money chasing too few investment opportunities creates the inflation in assets rather than goods & services. Bernanke could only opine that the Fed can't do anything to prevent an asset bubble.

2. When the subprime crisis started (just as capital inflows began to slow, by the way) Bernanke displayed his astonishing ignorance of the capital and foreign exchange markets by insisting this was just a subprime/housing problem and lowering interest rates (thereby boosting growth in China and we saw what happened to oil as a result -- our easy policy ignited global inflation) He should of known this was a collateral problem best solved through the open market desk and by the government buying up surplus homes rather than insolvent financial institutions.

Bernanke proved academics make a lousy Fed Chairman -- he had to bring the economy closer to his academic strengths, depression, before getting it right. In addition, he failed (as did Greenspan) to recognize the theory of second best, meaning, in this instance, you don't run policy as if we have free floating capital and foreign exchange markets when we don't.

This is not to say Summers or Yellen would be any better. The very fact that Summers is in the mix makes this very political choice an underscore to the regulatory changes in the financial sector. Once the economy is on the upturn the government wants the say on how the inflows of capital are to be allocated. After all, the deficit in national saving will be owed to the government not the private sector.