Bernanke Dogma

Will Bancroft takes a look at central banking, its intellectual foundations, and its most powerful agents today. What does it all mean for investors? We take a good look at the Bernanke Fed and the cartel of central banks, and wonder whether we are being well lead by our financial captains. Read on to learn more and see how these issues are linked to the gold price.
As we enter another financial year of the ‘new normal’, where we see zero per cent rates, apparent stagflation and high unemployment, we sit here with continued doubts and concerns. We’re worried. Who isn’t? Electorates all over the world can feel that something isn’t quite right.
Do our political and economic captains have it as sussed as they think? Or even partly sussed?  We suspect not.
Reading James Rickards’ recent book, Currency Wars, over the holidays reminded us of a thought provoking interview we listened to last year when Jim Grant appeared on King World News. Mr Grant is another of our favourite commentators, and publishes Grant’s Interest Rate Observer.
Mr Rickards and Mr Grant were sounding some similar tunes when it came to concerns about the actions of central banks today. Especially criticised is the Federal Reserve. Central banking has extended its remit in what is a mammoth example of ‘mission creep’.
Tumorous growth of central banking
Mr Grant’s observes how the Fed is involved in the stock market like never before because Governor Ben Bernanke has taken credit for rises in equity indices. Mr Grant feels this has backed the Fed up an apparent policy alley.
But I wonder what does it do? What can it do? What is it morally bound to do? If the savers who have been driven out of non-yielding deposit accounts. What happens to those savers if their equity investments suddenly are shredded? Does the Fed stand idly by? I don’t think it can. So I don’t think one can absolutely predict QE III, but I think the Fed will think long and hard before standing aside and letting the chips fall, when, not if the market suffers the next down draft.

Today’s world of negative real rates is ironic when you compare the conduct of the Fed today with the expressed intentions of the founders almost 100 years ago, and Mr Grant reckons that “it is as if the Fed were managed with the very purpose of negating every founding principle”.

The role of central banking

So what are the intellectual foundations of central banking?
Mr Grant suggests that the great British financial and political writer, Walter Bagehot, may be a good place to start. His book, Lombard Street, published in 1873, is one of the greatest intellectual contributions and justifications of central banking. However, Bagehot does believe that central banks are even needed at all.
Bagehot laid out four express rules for crisis intervention:
  • In extremis the central bank ought to lend freely
  • This lending should occur at a punitive rate
  • This lending should be against good collateral
  • This lending should be to solvent institutions

Mr Grant is fair to point out that central bank actions recently do not meet such advised standards. The central banks have acted in accordance with point one, but paid little heed to the other three.

The madness of bankers

What concerns us is whether today’s central bankers, and Bernanke has to take the spotlight because he manages the world’s largest economy and the reserve currency privilege, are acting with considered thought or are intellectually wedded to policy responses which may not be all they’re presented to be.
We agree with Mr Grant when he offers that “there’s certainly an intellectual cocksureness that has no grounding in the forecasting record of the Federal Open Markets Committee”. This reminded us of a Bertrand Russell quote: “the trouble with the world is that the stupid are cocksure and the intelligent are full of doubt.”
We fear that Mr Bernanke’s intellectual legacy will not be deemed as smart as the Princeton economics lab might have conceived it. However, it’s what will happen to our economies and savers that we worry about more.
After one of the best brief appraisals of the misuse of financial economics today, James Rickards, In Currency Wars, also offers some considered concerns about central banking and the potential mismanagement of the dollar today. Mr Rickards also refers his readers to Walter Bagehot, and had the following to say about the Fed recent performance:

“This was central banking with the mask off. It was not the cool, rational, scientific pursuit of disinterested economists sitting in the Fed’s marble temple in Washington. It was an exercise in deception and hoping for the best… America had become a nation of Guinea pigs in a grand monetary experiment, cooked up in the petri dish of the Princeton economics department.
The Bernanke-Krugmann-Svensson theory makes it clear that the Fed’s public policy efforts to separate monetary policy from currency wars are disingenuous… this is clear to the Chinese, the Arabs and other emerging markets in Asia and Latin America… the question is whether the collapse of the dollar is obvious to the American people”.

Gambling without understanding risk

Bernanke and his intellectual followers are playing a very high stakes game of poker. The play book for their hand in this game has a flawed appreciation for Monetarism and Keynesianism (we will discuss this in more detail another day) and has never worked before. One does not have to be an Ivy League economist to understand this.
Much of the public understands deep down (whether they publically admit it or not) how a general and pervasive financial irresponsibility lead us to the start of the Credit Crunch in 2008. We were all guilty, even if some at the heart of the system benefitted to a proportionately far greater degree.
This is why there is such widespread angst about the financial authorities and politicians who endorse them today.

As Nassim Taleb muses in a must watch interview: “Ben Bernanke is not only the man who crashed the plane, he is back in the pilot seat, and he is ignoring risks… he did not see the risk in the system before, why are you listening to him when he is talking about what to do?”

We know how debt works in our personal lives, yet we see the authorities piling up the debt burdens with their intellectual play book that seeks to rewrite the laws of economic gravity. More debt is used to solve a problem of debt. Easy money is thrown at every problem; just look at the ECB’s actions recently.

We are walking a tightrope

When discussing the certainty and confidence of market participants, Mr Rickards offers the below:

The danger is that the Fed does not accept these behavioural limitations and tries to control them anyway through communication tinged with deception and propaganda. Worse yet, when the public realises that it is being deceived, a feedback loops is created in which trust is broken and even the truth, if it can be found, is no longer believed. The United States is dangerously close to that point.

Our indebted banking system and governments are now so over-extended, when assessed through the lenses of monetary economists such as Professors Peter Bernholz, Kenneth Rogoff and Carmen Reinhart, that risk levels are palpable.
The loose monetary policy play book has now been dominating this game of financial poker for decades, has been most boldly played by Greenspan and Bernanke, yet we keep on seeing the same old policy responses. Barack Obama’s court of economic advisers offers few promising solutions. Debts continue to build.

Within this there are glimmers of hope. The Governor of the Bank of England, Mervyn King, the Chairman of the UK’s Financial Services Authority, Lord Adair Turner, and The President of the World Bank, Dr Robert Zoellick, have made some helpful suggestions which suggest proper and philosophical consideration of the status quo. Sadly, no critical mass has built behind these individuals.
The US president and the Chairman of the Fed still hold huge influence, and they continue to sail the good ship America with what appear intellectual blinkers. Will they end up colliding with an unforeseen object as the Titanic did?
What few of the major political and financial actors propose is to shrink and simplify the financial system.

The gold price barometer

Our barometer for confidence in the financial and monetary system is the gold price. With fair consideration to potential bumps in the road, we don’t see the needle of this barometer falling much anytime soon. The fundamentals that began to push it up the scales show no sign of dissipating.
Until we get back to basics, cut deficits, pay down or default on debt, and generally return to a society where greater responsibility is encouraged, our present system of big government and funny money will persist. We will look at this in greater detail in a future article.
Until such a future time, we continue to sit as worried observers to the financial system…
Watching central bankers extend and pretend…
Wondering what purposes central bankers exist for…
Watching politicians fail to grasp the nettle…
Watching electorates continue to vote for what cannot be delivered…
Let’s hope that Bernanke et al are not running us onto the rocks in catastrophic adherence to dogma.