Friday, November 14, 2008

Is Jawboning Bernanke's Only Currency?

In 2002, when then Federal Reserve Governor Ben Bernanke made his famous speech, "Deflation: Making Sure "It" Doesn't Happen Again", was it just behavioral propaganda designed to give the future Chairman street credibility? Just as an organized crime boss builds his reputation through a mixture of legend, occasional brutality and folklore, the Chairman's own legend as the premier academic scholar of the Great Depression and folklore such as a helicopter dropping reflationist seems to have all been premeditated and selected for this very moment in history.

Will it work?

Never has before. I guess there's always a first. Just like the crime boss seems invincible until he's laying in a pool of his own blood, the Chairman is perceived as infallible until he's irrelevant. Look back no further than the previous Federal Reserve Chairman, Alan Greenspan, to see how far off the pedestal they can fall.

And again we keep hearing daily why it's "different this time". The Chairman is creative. The money supply is exploding. They have it under control. Bob Hoye, over at Institutional Advisors (an absolute must read realist) puts things in perspective:

"Those close to Mr. Bernanke believe he can handle any worrisome economic conditions given his academic pedigree. He scored 1590 out of a maximum of 1600 on his SATs, has an economic degree from Harvard, and a doctorate from MIT. He has taught at Princeton for 17 years."

- That was from the February 1, 2006 edition of the Financial Post, which included a comment from Robert Frank who wrote a textbook with Dr. Bernanke:

"I'll bet on Ben's ability to see what is coming around the next corner over just about anybody else."

Some perspective on power and monetary madness is provided in an observation made by Mayer Rothschild in 1836:

"Give me control of a nation's money, and I care not who makes the laws."

In 2002 there was an event to honor Milton Friedman, and Bernanke's address included:

"I would like to say to Milton and Rose: Regarding the Great Depression you're right, we [the Fed] did it [caused the depression]. We're very sorry. But thanks to you [Friedman] we won't do it again."

In so many words, Bernanke claimed that the Fed had learned its lessons. The problem is that those (including Friedman) who have claimed that the post-1929 contraction was caused by a policy blunder have been wrong.

With adequate research anyone would conclude that great contractions are caused by great financial manias."


Is it arrogance, or just in the world's best interest to posture, "We (the Fed) did it...we won't do it again"? By attempting to own it, will they prevent the next crisis? I believe we are currently experiencing the inflection point where jawboning's considerable limitations are revealed, or simply where the rubber meets the road.

Wednesday, November 12, 2008


If Yogi Berra was a behavioral economist he might have said, “Perspective is 90%, the other half is dumb luck”. But for the majority of Americans, luck has been a part of our story as much as homemade apple pie and the white picket fence. In fact it has been our birthright. As a nation we have been sailing for quite sometime downwind and through the warm protected waters of the global financial system.

Now I realize there are significant populations of Americans who do not enjoy the wealth and opportunities of this nation, but for arguments sake, let’s assume most of us have enjoyed a comparatively privileged lifestyle. For the last century, each generation built upon the wealth of their successors. The European immigrant labors of the early 20th century established stable working class cities and neighborhoods to raise families. Small businesses enabled those immigrants a foothold to what we now call the American dream. Their children obtained at the very least a high school education with the possibility of a college degree and social security to see their modest dreams realized. And so on and so on.

Where that leaves us today is two or three generations of extremely privileged citizens who fully expect to continue the expansion of wealth that their parents, grandparents and great-grandparents extended to them. Unfortunately for all of us (I happen to be a card carrying member of one of these privileged generations), the wind’s have disappeared and we are currently sitting in the doldrums, waiting. Many of us are completely ignorant to the situation and its significance and fully expect conditions to improve just like they have time and time again in our lifetime, our parents and grandparents generations. However (and to continue the pretentious sailing analogies that seem so appropriate), I fully expect a storm to emerge that will capsize most of us floating precariously offshore and far from safety. From my perspective the storm clouds are everywhere, they have been for quite some time.

Let’s just keep this simple, we could blame everyone for today’s problems. Our grandparents for setting up our economy around a substance predominantly found in the Middle East. Or are great-grandparents for establishing the Federal Reserve and current banking system. We could blame our parents for well, everything from financial alchemy that enabled someone with no job and no money down to buy a two million dollar condo in Miami to electing George W. Bush for two terms. And surely we can blame ourselves for just being na├»ve, topical and downright spoiled. Step in Paris, Brittney and Lindsay. But in any case, all these problems and missteps were going to happen regardless of how the cards fell since the outcomes are inherently predetermined by our collective psychology and cognitive responses to these conditions, or simply, it's human nature. The crowd is the human equivalent of Mother Nature. You can try engineering controls (i.e. the Federal Reserve) to mitigate the punch and soften the blow, but like it or not the beast will walk and romp where it wants to.

Most people don’t realize that there have been many great depressions before The Great Depression. Interestingly, the time between the mid 1870’s to 1890 was referred to as the Great Depression. It took a few generations to build up the market psychology and greed of the 1920’s to outdo the generations gluttony before. If you ever hear someone say “It’s different this time!” run in the opposite direction.

Never a more fitting quote to the current times from arguably the most influential economist of the 20th century, John Maynard Keynes, “Markets can remain irrational longer than you can remain solvent”. It’s all a matter of one’s perspective and timing, sometimes guised as wisdom to the fool or as I like to call it, luck. I may have some insight here since I was trained as a geologist in my former profession. The geologist knows the arc of a certain process and understands time in the context of the universe. Take for example plate tectonics. Stress is placed between two colliding plates. Friction is the effect with conditions such as earthquakes, mountain building and volcanic eruptions. It’s not a probability, it is a certainty every time. For example, a geologist warnings of liaise faire building code enforcement in areas prone to seismic activity may not have been heeded for generations. The planning board chairman’s perspective of his own life extending some 60 years without incident is vastly different than the scientist’s perspective of geologic time or the historical record. The same goes for an economist warning of a global financial tsunami to a politician or worst yet, a stock broker. It all comes down to your own perspective.


Let's just get right down to things. You don't need me to tell you that the financial markets are broken. Just like Japan circa 1990 and the World circa 1930. Don't let anyone talk you down or sugar coat things with lists comparing why this time is different than the last great unwind. It isn't. In many ways it could be worst. I remember listening to CNBC's chief economist Steve Leisman proudly report in 2006 that all of the major 66 developed economies where enjoying parallel growth; and mind you not tepid growth, historic growth. I remember thinking, why is that good? In fact, I thought so much of the quote I wrote it down across the top of my white board in bold face. My concern was if we were all expanding at the same time there would be little to hold back the eventual contraction. And just as our collective expansion amplified our growth potential, the collective contraction would be equally magnified. These are the same principals taught in your high school physics class. When two waves of identical wavelength are in phase, they form a new wave with an amplitude equal to the sum of their individual amplitudes (constructive interference). My fear is the trough of this cycle could be a ways off, just as it was in the 1930's.

An interesting conversation keeps recurring to me. Friends and family inevitably talk about the financial crisis and why it appears overblown and even conspiratorial. Either, "the media is making people hysterical", "the bankers were corrupt" or "the government failed us". When I start rattling off why this situations closest historical equivalent is the 1930's, their eyes glaze over and you get the look of, "did this guy just say he was abducted by aliens?" In any case, today I got an email with Merrill's latest research on Bear Market's. It's take away:

"This is not 1929. The Great Depression was exaggerated by fiscal and
monetary policy mistakes.

• Global policy makers do not seem to be repeating them and that period
may be a poor comparison for today. "

My Brother-in-Law who had sent me the email had been attempting for several weeks to make the case of why this situation was not 1929. I found it quite funny when not a few hours went buy and I read the headlines from Merrill's own CEO, John Thain:

Financial Times- Merrill Chief sees severe global slowdown. Thain compares situation to 1929.

Mr. Thain went on to say, “Right now, the US economy is contracting very rapidly. We are looking at a period of global slowdown...This is not like 1987 or 1998 or 2001. The contraction going on is bigger than that. We will in fact look back to the 1929 period to see the kind of slow down we’re seeing now.”

Oops! Perhaps Mr. Thain is attempting to correct the irony of Merrill's own contradictory research. These are the same guys who told you why "it's different this time" on the way up in the Tech bubble, the housing bubble, the commodities bubble and now on the way down in the credit crisis. If this doesn't reinforce that it's just one giant ponzi scheme and these guys are the mother of all salesmen, yikes!

So where does that leave us today and what should I do with my money? I can't write this assuming individuals own risk tolerances and how they approach the market, but for me it's all about relative performance and perspective. Isn't that all we should care about in a deflationary environment? If the portfolios of my average countrymen are loosing 50% of their purchasing power and I only loose 25%, havn't I strengthen my relative purchasing power two times even though I lost 25%? The octogenarian investor Richard Russell once wisely described a bear market as a market environment where everyone looses, the winners are those who loose the least. This is the mentality to maintain in the current market environment, those who choose to be brave, ignorant or reckless will surely have their heads handed to them quicker than they can scream UNCLE.