Ben Bernanke's Latest Move is Bold, But Fraught with Risk

Bernanke's latest move is as bold as they come. But, its not certain to succeed.

Ben Bernanke's made a believer out of me.  He has proven himself to be a bold and decisive steward of the economy.  Whereas I and many others on this site have questioned whether he had the ability to take bold decisions, that has been answered.

Yesterday, Bernanke moved decisively to buy longer dated Treasuries and agencies, driving the 10-year bond yield down dramatically.  Investors cheered.  The equity markets went higher and gold took off (having actually been down strongly in the beginning of the day).  i am concerned that it represents a level of desperation and despair now that the Fed is running out of tools with which to affect the economy.

Bernanke's goal is clear to further free up credit markets.  He knows that this global economic collapse is caused by a housing collapse and he felt that by making cash less expensive, he could help to improve the market.  Jim Cramer was so elated by the move that he came on CNBC at 3 PM and told everyone to go out and buy real estate since Beranke just gave us all a gift.

We drove home ownership in this country to an unsustainable level in the middle of this decade.  And, that was created by unnatural forces in the market - loans that simply weren't rational. 

Greenspan created the housing bubble.  It got particularly out of hand when he drove the recession away after 9-11 by lowering rates so low that the housing sector kept the entire economy afloat as technology faltered.   By lowering rates again to unnatural levels, Bernanke is seeking to bail out the entire economy by reinflating the housing bubble, or at least stopping housing prices from further declines.  This interference in the free market can have intermediately positive effects, but ultimately market forces alone direct where the price of real estate is going to be.  It would be better that we come to terms with the current real estate slump and let prices reset, rather than keep real estate artificially high for years or decades on end in order to create as asset against which consumers may borrow.

I think that Bernanke got a signal from Chinese Primier Wen Jiaboa who last Friday urged the US to take measures to guarantee its good credit and expressed concern about Chinese large holdings of US Treasuries.  China is the biggest holder of US Treasuries and must have agreed that it would not respond to a US move by selling US Treauries or dollars (at least I hope that to be the case).  Nevertheless, Bernanke's move causes a fall in the dollar against other major currencies.  Those of us who are US centric and dollar centric don't need to be too concerned about this, but there are significant consequences to the global economy (and hence to our own economy).  I believe that our economy is a technology oriented one, and that we should not position ourselves to sell our products inexpensively in the global economy only to be able to turn around and purchase nothing but inferior trickets from China with our currency.

There are other risks to this move as well.  We are seeing a rush into commodities today that is dramatic.  It is driven by a fear among investors that the dollar devaluation will be met by further global currency devaluations, leaving commodities as a safe harbor.  As investors try to guage the "reflation risk" they run the risk of recreating a global bubble that will not be sustained, unless there is a terribly strong global economic rebound.

So, how do you play this now knowing that our currency is going to hell and that the dollar is worth 80 cents of what it was worth yesterday?  I am very cautious myself and am not chasing commodities (I have exposure to oil only).  I am also not chasing equities.  I think a 20% rally in 6 days in the market is driven by unrealistic expectations that the government's latest economic policies will be successful.  I would expect to see a pullback to lower levels on the S&P.

Bernanke's latest efforts, like TARP and Geithner's moves, are trying to get more lending going. I hope Bernanke is successful but I am terribly concerned that Bernanke is doing nothing but trying to defer problems to the future.

Jason Rodgers
Jason Rodgers: Jason Rodgers was an experienced research analyst for a major bank prior to retiring to run his own investment consultancy in beautiful Lihue, Hawaii. Jason contributed articles to BestCashCow from 2008 to 2014.

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