The Case Against Bernanke ~ Steve Blitz Morning Notes
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Tuesday, August 25, 2009

The Case Against Bernanke

Steve Roach (economist and chairman of Morgan Stanley Asia) in a commentary just released by the FT --

Barack Obama has rendered one of his most important post-crisis verdicts: Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve. This is a very shortsighted decision. While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing programme, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s. It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor. . . .

. . . Mr Bernanke made three critical mistakes in his pre-Lehman incarnation: First, and foremost, he was deeply wedded to the philosophical conviction that central banks should be agnostic when it comes to asset bubbles. . . .

Second, Mr Bernanke was the intellectual champion of the “global saving glut” defence that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia. While there is no denying the demand for dollar assets by foreign creditors, it is absurd to blame overseas lenders for reckless behaviour by Americans that a US central bank should have contained. . . .

Third, Mr Bernanke is cut from the same market libertarian cloth that got the Fed into this mess. Steeped in the Greenspan credo that markets know better than regulators, Mr Bernanke was aligned with the prevailing Fed mindset that abrogated its regulatory authority in the era of excess. . . .

Roach's last point goes to the heart of what I have been writing of late -- there is no sign, none whatsoever in recent comments by Mr. Bernanke that he has re-examined his libertarian view or at least has come to terms with that view as a central banker in a world where markets are elsewhere rigged.

The Bernanke reappointment is a welcome chance for a broader debate over the conduct and role of US monetary policy. Mr Obama has made sweeping proposals that give the Fed broad new powers in managing systemic risks. I argued in the Financial Times 10 months ago that the Fed should not be granted these powers without greater accountability as required by a “financial stability mandate” – in effect, forcing the Fed to shape monetary policy with an aim towards avoiding asset bubbles and imbalances. Without a revamped policy mandate, it is conceivable that we could face another destabilising crisis.

Ultimately, these decisions boil down to the person – in this case, Mr Bernanke – who is being charged with the awesome responsibility as America’s chief economic policymaker. As a student of the Great Depression, he should have known better. Yes, he reacted strongly after the fact in taking actions to avoid the pitfalls highlighted by his own research. But he lacked the foresight and courage to resist the most reckless tendencies of the era of excess. The world needs central bankers who avoid problems, not those who specialise in post-crisis damage control. For that reason, alone, he should not be reappointed. Let the debate begin.

Unfortunately the debate is done and the Congressional fawning begins. Mr. Bernanke will do his part by railing against fiscal spending while sidestepping the fact that the economic turmoils beginning with the 1990-91 recession have come from the mismanagement of monetary policy and not too large of a Federal budget.

Mr. Roach also makes the point, rightly so, that it is premature to declare Mr. Bernanke's efforts a success. Indeed, any sense of normalcy in the markets should be tempered by the fact that the Fed is still repoing all that frozen credit on the books of the banks. If the Fed put the securities back to the banks market normalcy would disappear in a hearbeat -- and so would Bernanke's chance at reappointment.

Moving the economy forward is going to be a long tough slog and unless we have clarity on the dollar/yuan relationship the U.S. will be back in the soup soon enough but without an underleveraged Federal sector to save the day.

President Obama made a choice that made the Fed's depositors happy. That doesn't make it the right choice or an inspired one.

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