Bernanke Said What?

Since the housing market peaked and the financial crisis began, the government has spent:
$3.6 trillion (net after some repayments) on various stimulus programs,
$16.3 trillion in government guarantees to various financial institutions; plus
$7.2 trillion in federal government spending (the budget) trying to hold up the economy.

That’s a lot of money for a $14 trillion dollar economy. Yet the net result so far is an economy barely growing at 1.6 %, unemployment at 9.5% (or 17% depending on how you count unemployment,) a very troubled housing problem (inventories last month were at 12.5 months supply) and a financial system that can’t afford to lend (for fear of future defaults and/or the risk-free money they are getting because of Fed policy.) And this is only a few of our problems.

Now, last Thursday at the Jackson Hole Conference (isn’t that more expensive than Las Vegas,) we were told by Federal Reserve Chairman Bernanke that he has changed his mind and the economy may be showing down even more than he thought. Also, that the economy can not even handle the Fed keeping the interest and early payoff money the Fed is receiving from the bonds it purchased. That he is going to spend that money as fast has he receives it rather than shrink the Fed’s balance sheet. What a confidence builder. Plus, and this a big one, that the Fed is ready to print more money, in addition to what they have already done, to keep the economy going.

We have been debating how the Fed is gong to reduce its balance sheet. Now we learn that even the simplest reduction seems impossible. So get ready for Quantitative Easing, round 2.

As you know, critical thinkers have to look at all sides of the argument. Here is a summary of their analysis and proposals.

The Keynesians, economists like Paul Krugmanand and James Galbraith, want the government to significantly spend more money because we didn’t spend enough to begin with. They say the economy is not recovering at all. Federal Reserve policy has been “grossly inadequate”. The Fed should increase its balance sheet from $2 trillion to $4 or $6 trillion (would this cause a printing company bubble?) Most economists are Keynesians and they are putting a lot of pressure on Congress and the Federal Reserve to stimulate more and print more money. They, as always, are concerned only about the short-term.

The Keynesian-lite or Supply-side economists like Brian Wesbury or Larry Kudlow want additional tax cuts and more incentives for businesses to expand and hire employees. They say the economy is recovering, but very slowly. I am not sure they still believe in the V shaped recovery. They also claim that uncertainty, especially in tax policy, healthcare policy and undefined new financial regulations are some of the reasons the economy is not growing faster. They also believe tax cuts and incentives will result in more production which will keep inflation low. But, since a tax cut without an offsetting spending reduction is a stimulus, it would mean more borrowing, more quantitative easing. They too are only concerned about the short-term.


The Capitalists like Peter Schiff, Mark Faber and other Austrian economists want the government to get out of the way and let the economy heal itself. Sooner or later, we have to get to price equilibrium (in housing, wages, interest rates, etc.) They say the government has already spent far too much money. They believe that the free market, if left alone, will self-correct. That is how we get to the bottom. That is a recovery, getting rid of the excesses. All this government intervention is doing is delaying the recovery and laying a base for the next boom or bubble. The mal-investments caused by artificially low interest rates and the excessive expansion of money not only delays recovery but cause the next boom. For example, what is going to happen to wind power when the stimulus goes away? Or what’s going to happen to bond prices when inflation (caused by inflating the money supply) begins to rise rapidly?

We all see the economy through different lenses, but I am sure you will agree that most Americans think spending and then printing the money are out of control. Short-term and long-term. We may not be able to go from over indulgence to austerity in one step, but we sure need a plan and we sure need to get started.

Are Our Economic Woes Behind Us Or Ahead Of Us?

The way the market has been performing (Dow hitting a high of 10,750 in September and now six months later, with volatility, it is almost flat at 10,550.) Does that mean our woes are behind us or still in front of us? Following are a Macro and Micro view of what is occurring and what might occur.

The Aggregated or Macro View of the Economy

There seems to be two overriding views of the economy. The first is that both demand-side and Supply-side economists (Keynesians) see the economy through the lens of an aggregated economic model or the GDP. When you look at the economy this way, you see the “big picture;” but you don’t see the depth or interrelationships among elements within the economy.

For example, you see the economy growing at 5.9% in the fourth quarter---exactly what, you as a Keynesian, expect. This gives you confidence that the government is doing the right things to fix the economy. First, monetary policy: lowering interest rates and expanding the money supply and than fiscal policy: providing stimulus to get the economy back to normal and subsequently growing.

Now, with the economy focused in Washington (where the money is) and the math looking better: 5.9% growth; you could see our woes as being behind us. Even though Q4 inventory adjustments contributed 3.4% of the 5.9% GDP growth and inventories actually fell $39 billion. That’s the way the GDP model works and you could say that since it fell at a slower pace, things are getting better.

I think the macro conclusion is that things are turning around and with some additional stimulus; the government can keep this economy growing.

The Capitalist or Micro View Of the Economy

The other view, the capitalist view, sees the economy as interactions between individuals (micro view) rather than as an aggregated model (macro view.) Therefore, they look at how the pieces of the economy work on a supply-demand basis with constantly adjusting prices to achieve equilibrium.

This view sees the 5.9% GDP growth but looks at the longer-term implications. For example, in 2010 we are going to get another peak in mortgage resets (July) at a very high level of about $97 billion and remain high through September of 2011. Once this second wave of resets begins (which was in November of 2009) it takes about three months to get delinquencies reported and another three months before we get foreclosure notices. How many mortgages actually go into foreclosure we can only guess? But it will be in the millions.

The government could forestall some of these foreclosures through various programs (loan modification, not letting homes go into foreclosure until they have been rejected by a loan modification program, continuing to allow buyers to make 4% down payments and subsidizing them with $8,000 cash, etc.)

Also, bank credit remains very tight. Banks are not only restricting loans, the Federal Reserve is telling them not to increase dividends or buy back stock so they can continue to build up reserves. If this doesn’t make it difficult to get loans, the a new accounting rule that goes into effect in the first quarter of 2010 which requires banks to disclose their off balance sheet investment vehicles, will make it even more difficult. The only company we’ve heard from so far is Freddie Mac and they said they may be considered insolvent when they report. They are however; going to continue buying mortgage backed securities that are at least four months delinquent (no worry, they are tax payer owned.)

Are our woes behind us or ahead of us?
We don’t know. If the government continues to kick the can down the road on mortgages and allows the banks to continue to increase assets, it could keep the economy going in the short term. But if mortgage foreclosures become a major problem (number of, no credit, continued unemployment, etc.) we could get another step down. Watch the GDP numbers, watch the delinquency filings, and watch the first-quarter bank results.