We’re at a truly fascinating crossroads in modern economic times. Financial theory as we have come to know it will be changed forever based on the recent actions of Ben Bernanke and global central bankers. Millions of textbooks will be rewritten in the coming 10 years and careers will either flourish or die on the back of the actions of these bankers. Those in favor of Bernanke’s legendary helicopter drop are celebrating a 6 month rally in equities, but a vital piece of the recovery puzzle remains missing. While Bernanke and Co. fire up the printing presses, and the banks sell the recovery hook line and sinker to the investing public, we continue to see very weak consumer trends.
As we sit on the one year anniversary of the demise of Lehman Brothers it’s most appropriate to ask what we have achieved over the last few months and years in regards to policy action. Many say we avoided the second great depression and praise Bernanke for his innovative and swift actions. Others (myself included) believe we have simply kicked the can down the road and foresee an end to Bernanke’s career that very much mirrors Mr. Greenspan’s. As we noted back in August, Bernanke’s real report card is less than impressive:
• 4 million lost jobs
• 4.6 percentage point surge in the unemployment rate
• 20% decline in the S&P 500
• 30% plunge in house values
• A 3.5% reduction in real GDP per capita
• 11% decline in the trade-weighed dollar
• 109 failed banks (almost matching the total from the prior 13 years combined)
If you think about the cause of the credit crisis (excessive debt, excessive leverage and a banking sector that is too large and too powerful) and what we have solved in the last year it’s actually quite apparent that we haven’t solved any of the structural problems that actually caused the crisis. The debt in this country is still extraordinary, leverage is making a comeback and the banks have grown larger in what has to be the most incredible power grab in modern economic times. Meanwhile, Bernanke is like the doctor who keeps the cancer patient on life support, but can’t for the life of him, figure out how to extract the cancer and create a healthy self sustaining life. The system still has the cancer, but the recent shot of Demerol has the patient feeling better. 50% better.
At the heart of this problem is the consumer. The bankers will tell you that our long-term structural problems reside in the banks (which is why they needed our help in the first place, remember?), but in reality this is a consumer driven problem. And the problems confronting the consumer are many. Unfortunately for Bernanke these are long-term structural problems that can’t be fixed with a printing press and a helicopter. The consumer continues to struggle under the weight of high debts, stagnant wages and massive job losses. The latest consumer credit report, however, showed that the deleveraging in the private sector is actually picking up steam:
Fresh data on consumer borrowing from the Federal Reserve released Tuesday provide further evidence that US consumers have turned over a new leaf. Consumer credit contracted a record $21.6bn in in July, and there has been a net reduction of $102bn in the nine months following the financial crisis of last fall. The details showed non-revolving debt outstanding, which is comprised largely of auto and other fixed consumer loans, was reduced by $15.4bn while revolving debt, made up mainly of credit cards, dropped $6.1bn. Part of the reduction in debt owes to bad loans being charged off, some is due to tighter standards and terms on borrowing, and bank officers are reporting a reduced taste for debt on the part of consumers.
Meanwhile, for the bankers, it is business as usual. We can be certain that Christmas 2009 will be disappointing for everyone’s children in the United States except for those whose parents are employees of Goldman Sachs and JP Morgan – record bonuses are coming.
Unfortunately for the Fed and Bernanke you can lead a horse to water but you can’t make it drink. Lending is a two sided coin and as consumers continue to tighten their purse strings they simply aren’t borrowing at a rate that the government would like to see. Much to Ben Bernanke’s dismay the velocity of money simply isn’t budging. You can drop money from a helicopter, but if there is no one to borrow it then your hopes for a credit driven recovery become very dim.
Even the incentives such as the cash for clunkers program prove to be having little positive impact on borrowing and overall retail sales as investors simply reallocate spending money. It will be interesting to see what sort of impact this program has on long-term spending. The early signs from the back to school season are nothing to cheer about. It looks like mom and dad bought a new car, but decided junior didn’t need the textbooks for school. The near-term positives of the government stimulus appear fine in theory, but are only compounding our long-term problems. Meanwhile, in return for their generous bailout money, the bankers continue to jam taxpayers with higher credit card rates and more stringent lending standards. BNP elaborates:
One reason consumers may not be responding expansionary Fed policy is that lending standards continue to tighten and terms are expensive. Spreads between the rates charged on auto loans and Treasuries remain elevated, although it is worth noting that auto loan rates are available only through May. However that is not likely the whole story, consumers have lost tremendous amounts of wealth and income and face continued uncertainty about job security. It is worth noting that amongst all of the green shoots in housing and manufacturing, consumer spending overall has remained very subdued. Unlike the labor market, consumer spending does not tend to lag the cycle, but help lead it so we continue to believe a subdued recovery seems likely.
Many have already crowned Bernanke as the next “Maestro” (sounds familiar, right?), but we will not know whether Bernanke succeeded for many years. Ignore the talking heads who tell you that Bernanke saved the global economy. The same mistake was made by many back in the 90’s when Greenspan tried to print his way out of trouble. Thus far, all we know is that Bernanke has whipped out the same exact cheap money playbook that Mr. Greenspan always turned to. The curse of cheap money has been felt by everyone over the course of the last 30 years as we promote an unstable and deeply harmful boom bust cycle:
David Rosenberg of Gluskin Sheff said it best:
All the growth we are seeing globally this year is due to fiscal stimulus; not just here in Canada and the U.S., but also in Korea, China, the U.K., and Continental Europe too. For 2010, the government’s share of global growth, by our estimates, will be 80%. In other words, there are still very few signs that organic private sector activity is stirring. For a Keynesian, government stimulus is necessary, but the question for an investor is the multiple one attaches to a global economy that is still relying on a defibrillator. The problem is that governments do not create income or wealth, and today’s stimulus is really a future tax liability. Curiously, that future tax liability is likely going to pose a roadblock for the return to a “normalized” $80 operating EPS estimate that strategists are now starting to pen in for 2011.
Albert Edwards of SocGen foresees a continuation of the deleveraging cycle that will be carried on the back of consumers:
The problem is that after the boom there will be a bust. The issue now is one of deleveraging and the deflation that is starting to unfold. The problem is that Bernanke is a slave to Milton Friedman’s view of the Great Depression (at Friedman’s 90th birthday Bernanke promised that the Fed would never allow another Great Depression to occur). The
Australian economist Steve Keen’s observation that “Bernanke’s dilemma is that he is living in a Minskian world while perceiving it though Friedmanite eyes explains his actions to date. It also explains why he will fail.
Will Bernanke succeed using the same cheap money game plan that Greenspan used? Perhaps in the short-term, but in the long-term it’s likely that Edwards is indeed correct. We are simply promoting a boom bust cycle that is built on no real organic strength as is evidenced in recent consumer trends. As Anna Schwartz said, we are fighting “the last war” and she is deeply concerned that we have lost it. The Fed has vowed to print our way out of this mess while allowing mistakes to go unpunished. The long-term bulls are dancing in the streets in recent weeks despite stock prices that are still 20% off their highs, 10% unemployment, a dead consumer and housing prices that are 30% off their highs. Don’t lose sight of the forest for the trees here. This isn’t a sprint we’re experiencing; it is likely to be a marathon. They say history has a way of repeating itself and this movie looks like one I’ve seen one too many times during the Greenspan era….The best thing that might result from all of this is that Ben and company actually are fighting the “last war”. Rather, the “last war” we allow them to so foolishly start….Unfortunately for the rest of us, that likely means we have more booms and more busts ahead of us.