It is an interesting academic question for Dr. Bernanke. “Perhaps we should consider asset prices in our monetary policy after all?” Nice to be considering that idea now, when it is too late. The Fed has toyed with the idea in the past, often obliquely through the wealth effect, and how asset price inflation affects the creation of credit in banks. Consider this post from RealMoney:
  | | David Merkel |
| The Media Overstated Greenspan’s Point | ||
| 8/26/2005 1:36 PM EDT |
Tony, you probably have more experience than me in this, so if you disagree after I write this, I defer to you.
I’m not sure the media didn’t get Greenspan’s point, but merely cast it in the most sensationalistic way. That the FOMC uses asset prices in making decisions is nothing new; the 1999 transcripts indicated how they used them with respect to the wealth effect.
Secondarily, though they haven’t stated it as plainly, when asset markets have an effect on depositary institutions, the Fed has a responsibility to protect the depositary institutions; the only real debate is whether it should be done through regulatory or monetary policy means. Cramer prefers regulatory means (boost regulatory capital held against risky loans), and I would agree, except that the Fed for political reasons doesn’t like to hold a smoking gun. That’s why they didn’t raise margin rates during the Nasdaq bubble, and why they are conducting a very quiet campaign through the bank examination process to put the fear of God into bank CEOs.
Where the media errs is that the FOMC would focus on assets solely. It’s just one criterion among many for a FOMC that has been notably elastic in their decision-making process (and monetary policy) during Greenspan’s tenure.
Partly, I see Greenspan’s comments as partly about the past to the present, but also pointing the way he would go in the future, if he had the opportunity. That said, barring unusual circumstances (i.e. a dilatory President Bush) he only has three FOMC meetings remaining … what Greenspan thinks about the future conduct of monetary policy is irrelevant, if the new Fed chairman thinks differently.
Position: None, but all of the likely successors to Greenspan worry me, and that is saying a lot…
I’ve argued in the past that both asset and goods/services price inflation should influence monetary policy. I’m no great fan of fiat money, but if you are going to have fiat money, you must regulate the growth and nature of credit in order to make the system work in the longer-run. Better we should move to a gold standard (after the crisis) or something like it.
Get the government out of the money and credit business. They have not done well at it. We would have more recessions/panics, but they would be shorter and sharper, but much easier for the system as a whole to recover from. Under a gold standard, we could not build up the kind of leverage that we have done now, or at the Great Depression.
So, Professor Bernanke, that’s a really interesting academic point about asset prices and monetary policy, but there are no bubbles to avoid now, and it is not possible to reflate a bubble, short of massive monetary inflation, leading to price inflation of real assets. Monetary policy works through stimulating healthy sectors of the economy; unhealthy sectors face credit spreads so large that moves by the Fed are useless, unless they themselves lend to or buy bad debt from the damaged sectors, with losses getting washed to taxpayers through reduced/negative seniorage.
And, if I may say it plainly… I think the governments and central banks of the developed world are going to find out that they are smaller than the size of the credit problems, which will lead to:
- A severe credit-driven recession, and/or,
- Significant socialization of the financial system (much more than what has been done so far), and/or
- Insolvency of several major developed country governments.
The problems of excess leverage can be shifted, but they can’t be eliminated by government action. I am repositioning my portfolio into companies that can survive the worst (hopefully), largely because I don’t think the present government policies will work in the intermediate-term.
“there are no bubbles to avoid now”
don’t you think there’s a treasury bubble? as faber sez http://www.abc.net.au/lateline/content/2008/s2389900.htm – ‘Treasuries should be trading like junk bonds.’
the US budget deficit/GDP has tripled from 1% to 3% in a year and is about to triple again to 9% next year, cf. http://eh.net/encyclopedia/article/noll.publicdebt – public debt/GDP is as high as any time since WWII…
re: “Significant socialization of the financial system” see delong http://www.businessdayonline.com/analysis/backpage/16794.html
Excluding that one, of course, glory. As I said, this is a shift of pain from private balance sheets to the public balance sheet.
Hi David,
Do you think maybe in a future post you could elaborate on what your criteria are for companies that can “survive the worst”?
Thanks
Who is the Cramer mentioned in the article?
Chris — such a post will come soon.
William — James Cramer. I wrote for RealMoney for four years. He was a lot better before he started Mad Money — now he is totally short cycle. A pity, because he writes some good stuff when he thinks longer term.
David,
I generally share your view on fiat money systems, and probably have not done as extensive a research job on past recessions as you have. But I have studied economic history and the era of the gold standard. Recessions were actually pretty severe. Peter Bernstein makes a decent argument that a fiat system could work better than the gold standard if prudent rules were followed. Of course, that is a big IF.
I’m glad to hear that you will lay out your criteria for which companies can survive the worse. How would design a portfolio of such companies in a way that would reduce dependence on such a specific scenario for outperformance.
Thanks.
-Paul