Bernanke Presser

We're going to veer a little into markets, finance and economics today, but this is important stuff for those of you wanting to understand what is going on in our cities. The failures of our financial systems are causing monumentous distress at the local level. There is a tendency when we are not fully informed to simply blame "the man" - that opaque conspiracy that is masterminded from some dark room, a plot that is taking from us hard-working people and giving to the elite. The truth is much less sexy, but a lot more shameful. And we're collectively bigger participants than we think.

A coherent narrative of our cities has to start with an understanding that the American pattern of development - a massive, post WW II experiment that you will not find repeated on this scale anytime, anywhere in human history - cannot survive multiple life cycles because it costs more to sustain than it creates in excess capital.

We're roughly two life cycles into this pattern and, having fully leveraged ourselves to keep this thing going, are now left with few options. The entire financial metldown, and the orgy of finance that preceeded it, are simply the last great push of a living arrangement that is coming to and end. How we deal with this reality will be the defining act of our era. Unfortunately, we are not doing a great job so far.

There was a report that was written about and received a lot of play yesterday, that being an IMF statement that indicated that the Chinese economy would surpass the U.S. economy by 2016. The "end of the American era" was the pujorative statement from the IMF that roused our collective bravado, but what is really startling to many is how quickly this change is happening. In 2001, the U.S, economy was three times larger than China's. Think that statistic is startling, ponder the implications of this quote from the article:

Of course, as MarketWatch’s Arends noted, sudden changes or unforeseen events could alter the future economic outlook significantly. If, for example, China were to suddenly dump all or even some of its estimated $3 trillion in U.S. dollar holdings, both countries would suffer huge losses. But while the American economy and the U.S. dollar could be damaged beyond repair, a Chinese recovery could, theoretically at least, rely more on its domestic market and other countries.

Unfortunately, instead of introspection, this is manifesting itself as a fear and loathing of the Chinese, who have done nothing in the preceeding decade but finance our development pattern with cheap loans made possible by the hard work of their people, hundreds of billions of which live in absolute poverty. I suppose we'll claim their predatory lending practices induced us to take on more debt than we can repay and then we'll stiff them by repaying in a devalued currency. That may feel good until we realize that a trip to the grocery store would then cost us $1,000; that is, if we even have the $400 to fill our car up with gas. We can hurt them, sure, if we shoot ourselves in the head. Is that really a coherent response to our current predicament?

There is some interesting theatre that is going to happen at 1:15 today. I will be participating in a Curbside Chat and so will not be able to watch the Federal Reserve Chairman, Ben Bernanke, hold a news conference where he takes questions from the near-mortals that claim to speak for us, that being the national press. I'm fascinated to see and hear all this all goes down. I wonder if you will hear any of the following questions asked:

• Mr. Chairman, the Tresury Secretary indicated last week that the low interest rates for U.S. debt reflect a strong global demand for Dollars. Do you agree and, if so, why is the Fed spending hundreds of billions on quantitative easing to lower interest rates?

• Mr. Chairman, why, in your estimation, is the Dollar dropping against the Euro when Euro-zone countries are having such large financial problems?

• Mr. Chairman, what role did the Federal Reserve play in creating the housing bubble and do you consider this type of asset inflation outside of the Fed's mandate?

• Mr. Chairman, you indicated in 2008, prior to the Lehman Brothers bankruptcy and the market collapse, that our financial system was strong. Is our system fragile today and, if not, what has been done since 2008 to systematically change it?

• Mr. Chairman, do you prefer boxers or briefs?

While I threw in that last question as a laugh, unfortunately it is more likely to be asked than any of the others I offer. And if all five were asked, the boxer/brief question would certainly be the headline answer our society would focus on.

For the record, you'll know the end is nearing for us financially when the President, the Treasury Secretary and/or the Chair of the Fed denounce the "bond vigilantes" and other speculators that are "damaging" the dollar. This is not likely to happen today, but keep that little insight in the back of your mind because it may take place soon. 

Of course, it would also be interesting to know what prompted the Federal Reserve to make a $200 million loan to a shell company run by the wives of two Morgan Stanley executives. That is a truly ridiculous story as reported by Rolling Stone's Matt Taibbi, but realize that it is all made possible by the immense power we have given all of these institutions in the name of keeping this whole ship afloat. I bet that question is also not asked, although it should be the first one.

Anyway, watch the press conference and share your thoughts here if you care too. I'll watch it myself Wednesday night and join in the discussion.

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Comments

[Herb Alexander]

Love your blog. Can you recomend reading amaterials and documentaries. We are trying to save our small UT town.
Thanks, Herb Alexander, Kanab Cares

[Michael N.]

“There are good reasons for why the recovery is slower than we would like . . . and I guess the only thing I can say is that while the recovery process looks likely to continue to be a relatively moderate one compared to the depth of the recession, I do think that the pace will pick up over time and I am very confident in the long run that the U.S. will return to being the most productive, one of the fastest growing and dynamic economies in the world. It hasn’t lost any of the basic characteristics that made it the preeminent economy in the world before the crisis and I think we will return to that status as we recover.” Ben Bernanke’s up-beat, final comment.

It’s hard for me to accept this comment as 100% truth, and surely Mr. Bernanke cannot belief it entirely, either. Why is it that those leading this country think it is beneficial to soften the blow to the American public by not conveying the complete truth? Does he really think that the U.S. will continue to be the most productive, fastest-growing, most dynamic economy in the world? I don’t, especially with the content of this post citing China passing the U.S. by 2016. And even if we’re not the best; so what? It’s lonely on the top. The best at everything eventually falls. Pursue perfection, but there’s nothing wrong with being second or third.

With this being Ben Bernanke’s final words, the entire conference left a sour taste in my mouth. I understand his job is hard, and that I’ve often judged the Reserve’s decisions as stupid while I don’t know what else they should have done. Someone help me out. What good messages did Mr. Bernanke convey today? What was worth taking away from watching this for an hour?

[Michael Hadden]

Chuck... I loved this quote... "their predatory lending practices induced us to take on more debt than we can repay and then we'll stiff them by repaying in a devalued currency." What if that was their objective all along? I'm not sure that the communist party doesn't have a collective ego big enough to believe that they can pull off bringing the US down while not mutually crippling their own country... At the rate they are building infrastructure, the transfer of physical wealth will have already occurred. They are turning our dollars into physical wealth as quickly as they possibly can potentially knowing that there isn't much more wealth to transfer.

Crazy thought I know but I'm down here in Georgia watching tornados spin off everywhere so I might not be thinking straight. Thanks for the thoughtful post.

[Charles Marohn]

Herb, Check out our recommended reading list and our YouTube page - lots of good information there - or email me your phone number and we can chat. marohn@strongtowns.org

Reading: http://www.strongtowns.org/reading/
YouTube: http://www.youtube.com/user/strongtowns?feature=mhum

Micheals - I tried to download the audio for my ride home from the Twin Cities last night (2.5 hours) but was unsuccessful, so I have only listened to the introductory comments from Bernanke and the media coverage subsequent. It is all too predictable that he indicated better days in the mid-term future while revising downward past reported results and revising downward the near-term projections. No cognitive dissonance there.

Two other things from the introductory comments....

I guess a two percent inflation tax is okay and within the Fed mandate of "price stability". When you compare that to a growth rate of less than 2%, we're going backward in real terms. It is unclear to me why this is acceptable - I would rather have the tax increase from Congress than the Fed inflate savings and investment away at 2% per year.

I also found it interesting how he referred to inflation expectations as being a driving factor for second order effects. I'm not sure how they measure inflation expectations, but it is surprising to me with all the reports from old economy giants like Wal-Mart, McDonalds and Starbucks warning of dramatic price hikes that the early warning alarms at the Fed would not be going off.

That is a good quote, Michael, and I agree with your assessment. It would be interesting to know what "basic characteristics" he thinks makes us the world's preeminent economy. How much of it does he think is a quirk of historical fate and opportunism, how much of it is the American system of governance and how much of it is "brilliant" Fed policy? Myself, I would say 90%, 10% and 0% respectively, which does not bode well for his conclusion of continued preeminence.

[Nicholas Barnard]

So, I'm going to veer off onto a tangent. Initially when I read "their predatory lending practices induced us to take on more debt than we can repay and then we'll stiff them by repaying in a devalued currency." I figured you were commenting on homeowners purchasing houses.. I attempted to tackle this in a blog entry of mine: Irrational Attraction to Homeownership, which was a bit of a blehish failure. I'm not sure the followup entry cleared anything up, but it at least made use of what I've learned here..

But the argument I made in my first entry, was that while no one flat out forced people to take loans beyond their means, they sure pushed them hard, and probably pushed people to do this.

In the same vein, China didn't force us to borrow money, but they sure made it easy, and as a result it never came to our collective consciousness that perhaps this wasn't a good idea.

So a final metaphor: Bars will serve you alcohol to no end, even if you have a cruddy hangover the next day. And if those beers are on sale? You'll likely drink more of them, even though you'll pay. Sure it isn't clearly the bar's fault, but the drinker was enticed into drinking too much.. Its a shared responsibility..

[Charles Marohn]

Nicholas - That line was my weak attempt at humor. Consumer protection advocates in this country are indicating that we need to restructure home loans and credit card debt because banks were engaged in predatory lending practices. The counter to that is that nobody ever forces anyone to take a loan. I was using that analogy with our national debt and China. The terms they are offering are really good (for now - the rate will adjust later, for sure) and they are loaning us money clearly knowing we have no means to pay it back. It would be a tragic irony (and more than a bit confusing to the Chinese, for sure) if we applied our parochial logic to our transactions with our foreign creditors.

One of our recommended reading books is Crisis Economics, which deals intensely with the notion of "moral hazard". Why are German banks loaning money to Greece knowing that they can not pay it back? It is simple: when the banks do enough loans, they know the gov't will have to bail them out of the Euro economy will tank. What do they have to lose? So they keep loaning the money, Greece keeps borrowing, everyone is making money and all is good....until it goes bad, then the public bails them out because the public is held hostage by the threat of default/collapse.

There is a banker joke that goes something like this: I owe you $100,000, that's my problem. I owe you $100 million, that's your problem. At a certain point the lender is in so deep that they have no choice but to continue on. When is this the borrower's fault and when is it the lenders? Who knows - they have both acted stupidly when you get to that point. A consumer advocate will cry predatory lending. The lender will says that they were not forced to sign the loan and nobody was crying foul when the money was spent. The reality is that none of this would happen if the moral hazard were not omnipresent in the current system.

American interest rates should be really high right now, but they are not. When the U.S. economy was faltering in 1999-2002, people were running for loans to supplement their incomes. The supply/demand for loans should suggest a higher interest rate, but the opposite happened thanks to the Fed. The result was excessive leverage, malinvestment and, ultimately a bailout.

In terms of your writing, Nicholas, keep at it. Don't be hard on yourself. A blog is a great place to sort out your thoughts - which is a lot of what I am doing - and it gets easier the more you do it.

Thanks for applying our work to your life.