OUTSIDE THE BOX : A Greenspan Put—For Now?

CBS MarketWatch March 8, 2004  

NEW YORK (CBS.MW)—More shock and awe from Ben Bernanke? Careful study of this rising federal reserve governor's March 2 speech suggests there might really be a "Greenspan Put" underpinning the stock market—great short-term, but ominous long-term.

Bernanke emerged from an obscure existence amongst the footnotes of arcane economic history texts only in August 2002, when first appointed to the Federal Reserve Board.

That November, he began his shock and awe campaign by asserting that, rather than accept deflation, "...the U.S. government has a technology, called a printing press (or, today, its electronic equivalent)" that would be used to generate rising prices. [Deflation: Making Sure "It" Doesn't Happen Here , November 21, 2002]

This inflationist speech arguably triggered the gold's subsequent breakout. But Bernanke was never qualified or even questioned by the Fed.

Subsequent, equally decisive speeches have made Bernanke the most significant Fed leader after Alan Greenspan—more significant, indeed, for those who prefer intelligibility. Any future president may have difficulty not appointing Bernanke Greenspan's successor.

Bernanke's adult life has been spent soaking in the history of the Great Depression. That event, it is now generally agreed, was essentially the fault of the Federal Reserve and other central banks.

The fact that Bernanke's expertise in central bank mishandling of new policies was apparently his main qualification to become a governor might suggest that the Fed now regards itself as once again an innovator.

This latest speech is titled "Money, Gold, and the Great Depression." On its face, it is a characteristically taut and elegant discussion of the 1930s. At a deeper level, it is a commentary on the aspirations of the modern Fed.

The speech displays:

Extreme solicitude for the banking system. Bernanke ridicules the "liquidationist" viewpoint that closure of weak banks was healthy, and emphasizes the damage done by the credit contraction caused by bank failures. Problem: the opposite policy, arguably in effect now, leads to "moral hazard"—promiscuous risk-taking—and privileges the management of financial intermediaries.

Suspicious sensitivity to stock market levels. Bernanke criticizes the Fed (probably correctly) for pricking the stock market bubble of 1929. But he then argues that the subsequent market crash itself did real economic damage. This type of thinking is what causes observers to believe that the Fed will try to prevent any serious market decline—the rumored "Greenspan Put."

Excessive collegiality with other countries' financial elites. Bernanke has a fine understanding of international economic relationships. Thus, unusually, he notes that in the 1920s France, by undervaluing the franc and hogging gold, may have materially contributed to world deflation. Nowadays, the Fed tolerates the undervaluationist echelon of Asian states currently led by China, which recycle their reserves by buying U.S. government paper. Which may be great from the perspective of the Fed, Wall Street and Washington. But it ignores Main Street America, eviscerated by underpriced completion.

Alarming preoccupation with the Fed's institutional power. Bernanke & Co. always blame the gold standard for the 1930s disaster. Gold Standard defenders would see this as blaming bullet wounds on the gun. The concept was mishandled in important ways in the '20s, in part because of the aftermath of World War I. Bernanke acknowledges all this—but still prefers to disparage the gold standard, thereby giving central bankers more freedom.

Bernanke's speech suggests Fed ambition on a scale not seen since the era of 1960s-style fine-tuning.

It's currently good for importers, Wall Street and other financial intermediaries, and the Chinese.

But it means a mounting risk of an anti-business reaction from its Middle American victims, 1970s-style exchange rate turmoil—and a return to the P/Es of that miserable time.