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Crash Course for Bernanke

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Final analysis will show that Bernanke can change interest rates but not attitudes, and attitudes are far more important.

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I am reading an interesting article from October 2000 called A Crash Course for Central Bankers. The following excerpt seems strikingly pertinent:

There's no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat.

History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

The Japanese Experience

Here is another paragraph from the article:

The downturn following the collapse of Japan's so-called bubble economy of the 1980s was not as severe as the Great Depression. However, in some crucial aspects, Japan in the 1990s was a slow-motion replay of the U.S. experience 60 years earlier. After effectively precipitating the crash in stock and real estate prices through sharp increases in interest rates (in much the same way that the Fed triggered the crash of 1929), the Bank of Japan seemed in no hurry to ease monetary policy and did not cut rates significantly until 1994. As a result, prices in Japan have fallen about 1 percent annually since 1992. And much like U.S. officials during the 1930s, Japanese policymakers were unconscionably slow in tackling the severe banking crisis that impaired the economy's ability to function normally.

It's amazing that anyone could possibly think that if only Japan had started cutting rates in 1992 instead of 1994 it would have made any difference. Unfortunately for the world, we now get to test out Bernanke's theories in real life.

The Great Fiscal Stimulus of 1929

Consider The Great Fiscal Stimulus Package... of 1929:

Herbert Hoover -- only nine months into his presidency -- assembled leaders from the public and private sectors to create an economic-stimulus package. Among the measures, Time magazine reported at the time, was a promise from Congress to offer bipartisan support for a tax-cut package. Also on the table was an assurance from the Federal Reserve that it would provide cheaper credit. Of course, there were a litany of public-works projects, plans for new corporate investments, and even a promise by Henry Ford to raise wages at his auto plants. None of this worked.

Certainly, our economy now has far more differences than similarities with the economy of 1929, and few expect a new depression for the decade ahead. But it's also worth remembering that the best laid plans of presidents, chief executives and senators can sometimes come to nothing.

Like the fiscal stimulus of 1929 the Fiscal "Stimulus" Of 2008 Is Doomed To Fail.

Yes, there are differences between 1929 and 2008. However, many similarities are striking.

Similarities Between 2008 and 1929

  • In the 1920s there was a massive overexpansion of manufacturing capacity. Today there is a massive overexpansion of productive capacity in China and a massive overexpansion of retail stores in the US.

  • In the late 1920s bank credit propelled a massive real estate boom in New York City, in Florida, and throughout the country. We now have the biggest housing bubble in history.

  • In the late 1920s credit was expanding at a rapid pace but there was no need for additional productive capacity. Today GDP is rapidly falling but credit is still rising (for now).

  • In 1929 there was no pent up demand for manufactured goods, especially autos. Today there is no pent up demand for homes, restaurants, retail stores, strip malls, autos, trucks or just about anything else.

In 2008 as in 1929, the ability and willingness of consumers to borrow and banks to lend is under attack not only in the US but Europe as well. For more on the latter please see Financial Crisis Poised To Hit Europe.

Four Reasons Bernanke Will Fail

For more on changing social attitudes please see 60 Minutes Legitimizes Walking Away From Homes.

Ludwig von Mises: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."

Final analysis will show that Bernanke can change interest rates but not attitudes, and attitudes are far more important. Indeed, changes in attitudes will render all of Bernanke's academic theories about the Great Depression meaningless.

Greenspan had the wind of consumers' willingness and ability to go deeper in debt at his back. Bernanke has the wind of boomers fearing retirement in the midst of falling home prices and impaired bank balance sheets blowing stiffly in his face. There is no cure for what ails us other than time and price. And with the aforementioned attitude changes, the biggest, most reckless global credit expansion experiment the world has ever seen is coming to an end. Central banks are powerless to do anything about it.


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