Economics Views
May 2, 2011
High-reaching Bernanke grows circumspect.
In Richard III, Buckingham became worried about the course the King was taking. Is Bernanke similarly worried about the economy’s course?
The US economy has done well—but not well enough.
At the Press Conference following the Fed’s recent policy meeting, Chairman Bernanke presented a slightly downbeat assessment of the outlook for the US economy. He noted that GDP hadn’t yet developed a self-sustaining momentum: jobs were being created relatively slowly and consumer sentiment was comparatively fragile. Given that the global business cycle is about to turn down, activity in the States looked set to continue to be dull.
Growth is sub-par; and more likely to slow than quicken.
In the circumstances, he didn’t think it appropriate to tighten monetary conditions. Although he was a little worried about inflation, he judged the bigger threat to come from recession. Indeed, if raw material costs were to stabilise in the months ahead—in line with an assumed moderation in activity in the rest of the world—US prices would cool of their own accord. He didn’t openly criticise who thought otherwise (Republican Party hardliners at home and Central Bank hawks overseas), but the implication that he thought them wrong was undisguised.
Bernanke is reluctant to tighten credit conditions.
He’s right, of course. The world economy is preparing to slow in the next two or three years. As a result, inflation’ll probably pose only a minor threat, but recession a major one. To restrict credit now would be dangerous; it’d repeat the misjudgement of the Fed in 1929, of the BOJ in 1989.
Even though he recognises the dangers of not doing so.
That said, there are risks attached to the deliberate promotion of excess liquidity. It’s possible that the policy’ll merely delay the economics downturn, not cancel it. And it’s not inconceivable that deferment will cause the correction, when eventually it occurs, to be steeper in consequence!
He’s worried also about the likely behaviour of financial intermediaries.
There’s an even bigger problem. Gratuitously easy money conditions encourage misbehaviour in financial intermediaries. The criminality that characterised the US’s sub-prime mortgage business in the middle years of the noughties was a direct consequence of the Fed’s generosity. Likewise the lack of oversight in Europe’s banks in the same period. Is the mitigation of the one problem worth the aggravation of the other? Who’s to judge these things?
Not an optimistic outlook, therefore.
It’s all very unsatisfactory. The medium term future is likely to be quite dull, perhaps very dull. And, if the worst comes to the worst, the longer term’ll not be much better. Japan has been struggling with the aftermath of a financial crisis for twenty years. Might the rest of us have to contend with something similarly protracted?
Will asset valuations continue to view things through rose-coloured spectacles?
Security prices have held up very well in recent weeks. Investors don’t mind “sales” weakness so long as it’s accompanied by “profits” strength. It has been: it’s workers who are being squeezed, not companies. Will it last? Possibly not. If the retrenchment were to intensify, bankruptcies to multiply, market sentiment would probably crack.
It’s unlikely.
But the key to valuations is liquidity. Tighter credit policies would cause investors to run for cover, the indices to slide. The financial sell-off would be fast and furious.
But any weakness will be modest and short-lived.
It might not last for long, though. Central Banks would panic if they saw both economy and markets in retreat. They’d turn on the taps again, despite their anxieties about misbehaviour. The chances are, therefore, that valuations, even if they tumbled towards the end of 2011, would be recovering again within twelve months.