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It’s Déjà Vu All Over Again

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Ben Bernanke has apparently added a little stand-up comedy to his bag of tricks. This past week, Chairman Bernanke indicated his belief that there are no “obvious” asset bubbles in our economy right now. To quote Bankruptcy Ben, "It's extraordinarily difficult to tell, but it's not obvious to me … there are any large misalignments currently in the U.S. financial system."

What is he thinking? The stock market is currently a huge bubble. From October 2007 to March 2009, the Dow Jones Average fell by about 50 percent. This is indicative of the fact that the previous market highs were out of whack for market conditions and needed to come down to reality. That is how the free market works when it is given the opportunity. Since last March, in just nine months, the Dow has rebounded off its low by an astounding fifty-three percent! It’s a bubble being fueled by all the cheap dollars the Fed is injecting into the economy.

If you don’t believe me, Mary Miller, director of fixed income for the T. Rowe Price Group indicated at the company’s symposium in Baltimore on Thursday, "I'm familiar with one institution that just borrowed $400 million — because they could — and then called up and said, 'What should we do with it?” That is what a lot of banks are doing with our money that has been given to them — not lending it but speculating once again in another Fed induced bubble. It is outrageous.

What is even more outrageous is Bernanke saying essentially that the current stock market fueled by his printing press is not a bubble. The economy is still in the dumper — I won’t bore or depress you further with all the numbers, but the stock market continues to climb to exorbitant highs. Give me a break and come clean Mr. Chairman.

Bernanke is clearly being disingenuous because if he acknowledged the truth it would indict the system that he has made a very good living from. The Federal Open Market Committee must be agonizing over whether to leave interest rates at essentially zero and continue to perpetuate the stock market bubble or raise rates and watch that bubble burst. It is going to happen sooner or later — sooner would still be painful but less extreme. Bernanke may not know it but the no win quandary he faces explains to a degree the Austrian School of Economics’ Business Cycle Theory.

Under this theory, business cycles, circular boom and bust periods, are not considered a natural phenomenon of free markets. Instead, government interference in the economy, specifically through manipulating the money supply, is the culprit. Booms are caused by artificially low interest rates and busts occur when the Fed decides to provide an “easy landing” for an overheated economy by raising rates. In both cases, low rates and higher rates, fallible humans at the Fed decide the rate levels. Thus, the market plays little if any part in the determination. Having been taught in an American public school, I was cynical myself of this analysis. After all, my Franklin Roosevelt loving social studies teachers taught me that capitalism has certain failures which we need the government to correct for us.

However, by looking at historical data it is possible to see the correlation between low rates (the cause of booms) and higher rates (the pin that punctures the bubble) and booms and busts. Because I have a day job, I only had time to analyze rates and recessions since 1971. 1971 is significant because that is the year Nixon opened the flood gates for the Fed’s printing presses by abolishing the last vestiges of the Gold Standard. The following is the year of recession followed by the lowest rate during the preceding period, the highest rate during the preceding period, and the spread between low and high rates:

November ’73: 5%-11% – 6 points
January ’80: 4.75%-15.5% – 10.75 points
July ’81: 15.5%-20% – 4.5 points
July ’90: 5.875%-9.75% – 3.875 points
March ’01: 3%-6.5% – 3.5 points
December ’07: 1%-5.25% – 4.25 points

Source: www.chartoftheday.com

The most important observation that can be made from examining the data is there was a significant spread between the lowest rate and the highest rate before each recession. These wide disparities in rates sent the wrong signals to investors and entrepreneurs. In other words, because money and credit were in abundance during artificially low rate intervals entrepreneurs invested in ways that market forces would have prevented if the supply of money was realistic (market determined). Thus, a misallocation of resources took place. Too many products were produced; too many houses were built; too much money was invested in companies with little or no earnings. All this happened because money was cheap and plentiful. Remember folks borrowed millions and invested in dot com companies before many of them even went online. Also, remember that right now we still have a glut of homes because Alan Greenspan kept rates near one percent for close to three years! Of course it was the housing crisis that led to this current recession.

When the Fed pulls the rug out from under the artificially propped up economy by raising rates significantly, thereby increasing the cost of money, people stop borrowing and many lose their jobs because products and services are no longer being bought with borrowed money. With higher interest rates, adjustable rate mortgages rise and homebuyers default on their debts. Asset prices fall and unemployment rises due to further cutbacks in consumer spending. The bubble is burst and recession sets in.

Now, recessions are unfortunate, but necessary like vomiting is essential during the flu – to rid the organism of bad material. In the case of the economy, the bad material is all the mal-investments that were made during the boom.

Of course, our economy was not given the chance to vomit the mal-investments made during the last boom. Through so-called “stimulus” and the easy money policies of Bernanke’s Fed we are into our 24th month of recession. What’s more the reckless monetary policies of the Fed have blown up another bubble in the stock market.

Which brings us back to the beginning of our article – Bernanke must be joking; there is a huge bubble in the stock market because there is no good reason for the extraordinary rise in stock prices given that consumers aren’t spending; commercial real estate is about to hit a crisis; and unemployment is still rising. The only explanation is a bubble caused by artificially low interest rates. In the words of Yogi Berra, “It’s déjà vu all over again.” The bright side is perhaps Bernanke can find work as a stand-up comic after his tenure at the Fed is over. He does get a good one off every now and then.

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About Kenn Jacobine

  • The rising unemployment rates just makes you wonder how the he is economy recovering!!

  • Where we’re at: The Jobless Scary Movie.

  • It may well be too late. The time was ripe when the going was good, but no one apparently had the foresight. We talked then, remember, of the benefits of “office automation,” shorter work-week, and greater leisure time for most Americans. Pipe dreams they turned out to be.

    So now, rather than being in the vanguard of spreading wealth and prosperity worldwide, we’re quickly joining the ranks of the impoverished, “second-rate” nations and the process of globalization and general leveling is not only imminent but well nigh complete.

    I still regard Robert Reich’s The Work of Nations as prophetic, a blueprint for times to come.

  • Kenn Jacobine

    How do we train all those workers to convert to a technological economy – we are broke and continue to send hundreds of billions overseas to friends and foes alike?

  • When I started working on Wall Street in the sixties, $100 a week was a decent salary for an entry-level position – equivalent to at least $300 nowadays.

    “We apparently can produce what our country makes with a much smaller labor market and this is not a good sign for America.”

    I’m not certain I agree. It should be a sign of increased efficiency and technological advance – the former a mere consequence of the inevitability of the latter. The problem seems to be – we haven’t expanded the technological sector fast enough so as to absorb all those who have been and are being displaced from manufacturing.

    Thus, just as the transition from a preindustrial, cottage type of industry to a fully industrialized society was accompanied by a great deal of hardship, the present aches and pains are evidence of a similar systemic change – this time from an industrial to a technological mode.

  • Kenn Jacobine

    Unemployment continues to rise because our economy is based on debt and not savings, frugality, and hard work like in the old days. We apparently can produce what our country makes with a much smaller labor market and this is not a good sign for America. It is indicative of the fact that we have lost our industrial base because of the demands of unions, and government egulations. The former caused primarily by the debasing of our currency by the Federal Reserve – workers need higher wages to live. Of course, “mainstream economists” say higher prices are caused by rising wages. People do not ask for raises until they feel the pinch of higher prices. Higher prices are caused by the Fed’s printing press.

  • An interesting quote, Kenn, from today’s Washington Post op-ed:

    Yet there is a lesson for the president in the rote quality of his Thanksgiving proclamation that is significant only because it reveals Obama’s underlying problem: What the document lacked was any sense of fighting spirit, any larger purpose, any gauntlet thrown down before his foes.

    Contrast it to a Thanksgiving message Franklin D. Roosevelt offered in 1934 that was unapologetic in declaring his political goals. “Our sense of social justice has deepened,” Roosevelt insisted. “We have been given vision to make new provisions for human welfare and happiness, and in a spirit of mutual helpfulness we have cooperated to translate vision into reality. . . . We can truly say, ‘What profiteth it a nation if it gain the whole world and lose its own soul.’ ”

    A year later, Roosevelt was at it again. “We can be grateful,” he wrote, “that selfish purpose of personal gain, at our neighbor’s loss, less strongly asserts itself.”

    Roosevelt was no less pragmatic than Obama. He, too, was attacked demagogically as a “socialist,” and was equally loathed by his adversaries.

    Yet Roosevelt was a “happy warrior,” a phrase he used about Al Smith that actually described FDR himself. He relished taking the fight to his enemies, once boasting: “I welcome their hatred.”

    Obama will have more to be grateful for next Thanksgiving if he accepts that his foes intend to fight him for the next three years. He needs to discover the joy that FDR took in fighting back, even in official documents that normally pass unnoticed. (End of quote)
    Obama’s Thankless Thanksgiving.

    Apart now from what you or I may think of FDR’s economic policies, there was at least an inspiring message – if only a call for a kind of national unity in the name of, shall we say, “the public good.”

    Now there is none.

  • I thoroughly agree with your #8. In spite of the rabid defenders of the stimulus package by some on the left, my thinking is it has been of no effect. The staggering growth of the army of the unemployed is an argument one cannot ignore – however much it is the case that unemployment is a lagging indicator. I don’t care what anyone says, this is no kind of recovery.

  • Kenn Jacobine

    I agree. Who once said, a fool and his money are soon parted? Consumers do need educating, but they are not going to get it in the government run schools. People still buy cash-value life insurance for God’s sake – that has got to be one of the dumbest things you can do with your money. Not that I am for it, but Washington will not regulate this scam like it regulates others because the insurance companies are in bed with the politicians. It just makes my blood boil.

  • “but I guess there is a market for them or Coke wouldn’t make them.”

    Perhaps. Or perhaps it’s one way for Coke to entrench itself as “the industry leader.”

    So the point may well be that you can’t expect the industrialist to subscribe to the policy of eliminating “social waste” when confronted with dumb consumerism and frivolous spending. Which is to say that educating the consumer may well be the first step, for only then it would lead to anything approximating socially beneficial productive activity in the business sector.

    And I don’t think that having such a goal in mind necessarily smacks of socialism.

  • Kenn Jacobine

    Sorry Roger,

    One more thing – you must admit that the trillions the Fed and Treasury have pumped into the economy has not helped unemployment. It is like with nature – the waves after an oil spill will cleanse the beach, but if you add more oil the mess is bigger and takes more time to clean.

  • Kenn Jacobine


    The point was that capitalism doesn’t cause the severe swings in the economy that we have experienced. The Federal Reserve and government intervention – welfare to corporations and individuals, public works programs, and other so called government stimulus plans cause the wild swings because the market is circumvented in decisions about the most effective and efficient use of scarce resources. Even when we had a Gold Standard and before the Fed. Washington favored banking by allowing it to have a monopoly on our money and by allowing them to practice fractional reserve banking. Banking interests have dominated the power in our government since Hamilton. Certainly because you are a liberal and I am a libertarian we can agree that it has been and is the financial power brokers that pay for successful campaigns and thus get their way in Washington much to the detriment to the working man.

    You know every time I return to the U.S. (about once per year) I am amazed at how many new flavors of Coke there are. I don’t know why we need them all either, but I guess there is a market for them or Coke wouldn’t make them.

  • Interesting article, Kenn, especially the analogy to vomiting when hit by a flu. Not that I agree with you on all points, but you do present a viable critique of the interventionist remedy to market’s ups and downs. In short, you almost make me a believer.

    There’s still a problem, however, of how to spot the bubbles and artificial market gyrations before they occur and nip them in the bud. It’s this, perhaps, which is the perennial weak/blind spot of the capitalist system: the apparent divorce between profit-making (read: pure profiteering) and what I’d regard socially-responsible productive activity.

    For example, do we really need ten brands of toothpaste? It’s this kind of waste of productive capacities, a misdirection indicative perhaps of lack of ingenuity, which gives capitalism a bad name and serves as an invitation to hucksters and self-serving financial speculators. If we could only strengthen the system’s defenses against such abuses, we might be able minimize the frequency and the intensity of business cycles, but how . . .

    Minimizing the hardships during such cycles – the unemployment problem – is another weak spot. Thus far, we haven’t been able to do so effectively. And so, apart from the first-mentioned aspect, it is in this area, perhaps, that our failure has been most conspicuous. The up- and down-cycles could be tolerable if we could lick the unintended side effects.

  • Kenn Jacobine


    The link is: here.

    [Please don’t post raw URLs, guys. Comments Editor]

  • Kenn Jacobine


    The problem is that the bankers will know to decouple from the market, but most working stiffs won’t. The next collapse – IRAs, 401Ks will then happen. You would think, fool me once shame on you, fool me twice shame on me.

  • Ruvy

    Bubble bubble, toil and trouble;
    Bubble bubble, gold is double!

    When are you guys going to figure out to forget the casino and invest your money in gold coins? Gold is the only thing that has gone up!

    The stock market has decoupled from the economy, and so should you!

  • Sammy

    The stock market has pretty much completely decoupled from the rest of the economy. Every green day is fueled by some new measure, or an overly optimistic projection given by some company with stakes in the game (which is usually revised down later). 100% smoke and or mirriors.
    As far as the FEDs go its obvious they have no concern for the future of this country, or the dollar. They have to know what they are dong is just prepetuating. But they know as long as they can inflate a little to make the people think they are wealthy enough to go buy some crap, then they can leave the mess for someone else to clean up later.

  • Mark

    pg 1 Austrian School of Economics’ Business Cycle Theory. link isn’t working