An assessment of a 7-year old speech. Part 1

Like Ma$e in 1999 we Double Up!
This post is divided in two parts.

”The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”

These are the words of Ben Bernanke from a speech he gave before the National Economists Club, Washington, D.C. November 21, 2002, long before he was elected Chairman of the Federal Reserve. What he did not know back then was that only six years later he would find himself and the world thrown into the worst economic crisis since WWII and that he would indeed keep the presses running. Recently the Fed decided to continue its QE-program and to expand it. That means another $ 1.4 trillion from the presses!

What is interesting is that Bernanke in his speech presented a theoretical base for how the Fed would be able to stimulate the economy with interest rates at zero and that today interest rates in the U.S. and many other countries are precisely zero or near zero.

To see the relevance of this today and to see why it can be interesting to look closer at what Bernanke said in his speech let us take a closer look at what deflation and its effects really are. To use Bernanke's own words from 2002:

"Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers…/…/the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress."

So, a sharp decline in demand which leads to deflation which then leads to recession, rising unemployment and financial troubles. Sounds familiar anyone?

Surely, the present crisis did not start because of deflation that was caused by a decline in aggregate demand, it happened because of bad loans in the financial sector. These loans have however led to a colapse in worldwide demand and that has in turn led to inflation turning negative in many parts of the world including Sweden, where inflation was -0,7 % in november, in other words; deflation. It has also led to rising unemployment, the worst recession since the WWII and global financial markets in crisis and interest rates close to or at zero. Although these current low interest rates are not a result of deflation but rather conscious decisions by central banks, they have however put many central banks including the Fed in the situation that Bernanke was discussing in his speech 2002, leaving them without their traditional weapon to stimulate the economy.

(This post is continued in the post below)

A milli, a milli, a milli, a milli

"A million here, a million there"

Maybe Lil' Wayne was predicting the future in June 2008 three months before Lehman Brothers filed for bankruptcy? Probably not. But at least it would have been another way of looking at the crisis.

We live in times of crisis, the worst crisis since the Great Depression in the 30's. It is this information we have become accustomed to during the last twelve months. The information has often come from the media, but it has also been the contents of a wide array of statements from all of chairmen of central banks and chairmen of various institutions to prime ministers and presidents. Lately though, it seems like the wind has turned, and then turned again. Not so long ago it seemed like the crisis was over but in the very recent past, it seems that the risk exists that the crisis will be protracted. Even Reinfeldt had some good points about the risk of a protracted crisis recently in his speech at the opening of the European Developement Days in Stockholm.

What may be worth considering is that even though the world may be in a Depression-like crisis, such statements can be made considerably more nuanced. Everybody is not living through a crisis and many still have a long way to go before they get out of it.

In some parts of the world, people always live in a "recession". It's really that which is and always has been our world's real problem. It's easy to find the current situation a bit ironic when it is only when the prosperous part of the world are losing huge sums of capital that forces are joined, politically and economically, to fight for a common cause. Unfortunately, this is an entirely different discussion.

However, there are those, including this myself, who fortunately still has never experienced a recession. There are even those who gain from it. Those with investments in the Swedish stock market has seen its assets grow by up to 50% since March, may well be that many of them also saw assets decline by much more than that, if they did not, for once, do right selling in panic after Lehman Brothers was allowed to go bankrupt in September 2008. Althogh with today's interest rates dividend yield on a stock is still significantly higher than the interest on a bank account, so perhaps it is not surprising that the stock market has rocketed without any fundamental change?

In the real economy however, things look different. Unemployment in the United States is the highest in 26 years and here, where I currently find myself, in Spain, 80 367 persons lost their job in September and it does not seem like October will offer any happier statistics. An unemployment rate of over 20% is no longer an unthinkable scenario. Adding to this there is a large deficit in the public finances which has now forced the decision on tax increases in the midst of the crisis.

As I mentioned earlier are, however, the point is that not too long ago we learned that the crisis was over. It was reported that key indicators pointed in the right direction, which was immediately interpreted as the end of the crisis. The problem is that the economy right now is on steroids so it would be rather strange if the economy did not show signs of some form of recovery. All the billions of various currencies that have been pumped into the economies in terms of stimulus and support packages and the QE (quantative easing) that the U.S. and Britain have been engaged in, ought to have some sort of effect on the financial system and perhaps it is just that which we have seen recently. QE is very briefly a way for a central bank to stimulate the economy with interest rates near or at zero. This is done through the purchase of securities with short maturity, for example, domestic debt and corporate bonds. These are paid for by the central bank by simply creating money from nothing. In this way the central bank increases the monetary base (M0) and through the money multiplier wishes to increase the amount of money in the economy. The idea is that the banks, thereby will increase its lending business and companies in turn their investments. However, this requires that banks and businesses use the money for lending and investment and do not keep them as security. The effect is otherwise very small and the risk is that there is too much money in the economy if conditions get better, which can lead to high inflation. Britain went right into its sixth quarter of declining GDP, so the question is if that is not exactly what is happening and how much effect QE really have right now and for how long it can continue.

I believe a lot depends on the expectations that exist about the economy. World leaders have perhaps unwillingly been contraproductive by using all these doomsday prophesies since the beginning of the crisis. The extremely low federal funds rate, highly concessional loans to banks and QE are all intended to stimulate the economy, which it has also done to a certain extent. What however, has not happened, and that is the big problem, is that it has not stimulated any real demand from businesses and individuals in the way that would usually be the case. For although people now have much lower interest costs and maybe even borrow more, (it may seem bizarre, but with today's interest rates many people probably have too few or small loans) they do not consume more. Business investment has in turn almost completely stalled. It is here the doomsday prophesies come into play and here I would like to support what I said earlier that not all are in a recession and a bit more nuanced statements are needed. The people who actually has gotten better off during the crisis do not spend their money, which is what normally tends to happen. It is precisely this which would be best for the economy, if all of us who are not affected by the crisis just continued as usual, and maybe even took the opportunity to exploit that we actually have gotten better off. Then why don't we? Why are the purchases of cars, white goods and other similar goods postponed? I believe that ordinary people's expectations have been strongly influenced by all these doomsday sermons during the financial crisis. A decade of continuous growth and low inflation has led to a very great confidence in central banks and therefore we believe them even when they say that the world as we know it, is collapsing. As many probably know, it is precisely people's expectations which largely govern today's global economy. Negative expectations may force a devaluation, make interest rates shoot through the roof and lead to uncontrolled inflation. Positive expectations on the other hand can lead to increased consumption, increased investment and increased lending. The last one ironically being precisely what caused the crisis.

The central banks of course know this. Perhaps therefore they hope that we will believe Ben Bernanke when he says that the crisis is over and begin to consume as before? Otherwise, there may be a risk that the crisis will be long and drawn out? It is possible that the financial crisis is over and that the financial system is saved. Although, I doubt strongly that the crisis in the real economy is over.

This however, is not to say that everyone is in a crisis. Australia, for example, has already raised its interest rates again, and they were never particularly low. Again, everybody is not in a crisis and with a bit more nuanced and flexible statements from the people who actually enjoys great trust, perhaps all these measures in the economy would have a greater impact and those actually affected by the crisis could recover faster.