The American Economy: Good News and Bad News

Ben Bernanke, the Chairman of the Board of Governors of the Federal Reserve System of the United States, must be feeling a bit frustrated by now.

As soon as he observes a set of consistent signals that the American economy is strengthening, he’ll likely opt to restore interest rates to higher (i.e. relatively normal) historical levels. On the other hand, as soon as he observes a set of consistent indicators that the economy is weakening, he’ll probably opt to move even more aggressively to stimulate the financial markets.

But what will he do if he doesn’t observe any consistent signals at all? In other words, what if he continues to take note of signals that contradict each other?

That’s what happened to Ben last week, when mixed signals about American consumers were released to the financial markets. Good news was embedded in bad tidings, and bad news in good tidings as well.

It’s Good News, Or Is It?

What good news cheered the markets? It was the report that American household debt levels had climbed for the first time since the pre-crash days of early 2008. Although excessive debt is undoubtedly a worrisome situation, many financial pundits interpreted the increase as a sign that consumers are feeling more secure about their jobs and their futures.

On the other hand, some noteworthy concerns were embedded in this good news. Apparently, the increase was largely attributable to surges in student tuition and automobile loans. Although automobile purchases undoubtedly stimulate economic growth, student indebtedness has been “in the news” lately because of its debilitating effect on the work force.

In other words, the news about debt was generally good, and yet one of its underlying causes was cause for worry. That’s the type of “good news, bad news” data that tends to drive federal regulators up a wall.

It’s Bad News, Or Perhaps Not?

Meanwhile, the markets received some unabashedly bad news too. The median annual household income in the United States has fallen to its lowest level since 1995. In other words, a full thirteen years of economic progress in the late 1990s and early 2000s have been fully reversed by the past four years of deep recession and the ensuing tepid recovery.

Furthermore, even though economists claim that the recession of 2008 and 2009 ended some time ago, annual household income has fallen each year for the past four years. Although the national economy has begun to grow again, consumer wealth has continued to slide significantly.

What good news can be gleaned from this depressing statistic? Interestingly, both the Democrats and the Republicans appear to have found a political “talking point” in the data. The Republicans claim that the recent slide in household income can be blamed on President Obama’s economic stewardship. And the Democrats counter that the recession actually began during George W. Bush’s term in office, and that his eight years of service failed to generate any permanent wealth for American consumers.

Quantitative Easing, The Third Generation

These mixed signals have persuaded Ben Bernanke to announce additional actions to stimulate the economy, but to implement them at a scale that is unlikely to trigger massive growth. Skeptics like Nobel Prize economist Paul Krugman have noted that unlike President Teddy Roosevelt, who advocated that the American government should “speak softly but carry a large stick,” Chairman Bernanke appears to be adhering to the reverse strategy.

On the one hand, he has vowed to prioritize economic growth and the employment of American workers as highly as the goal of monetary stability. That’s a major step in a new direction for a government bank that has long focused primarily on maintaining the value of the American currency.

In fact, the Chairman has pledged to maintain low interest rates for the foreseeable future in order to encourage lending and investment activities. And he has expressing his intention to engage in a third round of quantitative easing, a technical term that refers to the injection of federal funds into the financial system through the purchasing of debt securities.

Nevertheless, many pundits have noted that such actions may only affect the American economy to a limited extent. More drastic actions, such as the large scale nationalization of all of America’s global banks, were once debated but are no longer under serious consideration in the United States.

Muddling Through

Although the American equity markets continue to demonstrate significant strength, most economists predict that the United States will continue to muddle through its financial quagmire. With Europe remaining in a banking crisis and Asia troubled with slowing growth and territorial disputes, it is difficult to anticipate any external positive surprises that may jolt the American economy towards renewed prosperity.

Chairman Bernanke might thus be advised to acclimate himself to the current condition of mixed signals. Although “one step forward and one step back” might be a frustrating sequence for any one who wishes to make definitive progress, the American economy appears to be stuck in that very rut for the present and the immediate future.

Ben Bernanke vs. The Black Swan

Congratulations to Ben Bernanke, the Chairman of the Federal Reserve Bank of the United States, for being named Time’s Person of the Year!

2009 was most certainly a difficult year for the nation in general, and for regulators of the financial markets in particular. Because we began the year on the precipice of what Nobel Prize winning economist Paul Krugman called the Second Great Depression, but then ended it on the threshold of an economic recovery, we heartily agree that this honor is well deserved.

It is somewhat disconcerting, though, that Chairman Bernanke continues to acknowledge that he didn’t anticipate the collapse of our financial and economic systems. That being the case, one cannot help but wonder whether he is responsibly planning for the emergence of the next black swan.

They’re Not All White

Huh? A black swan? Aren’t all swans white?

In reality, black swans do exist, and they played a prominent role in Nassim Nicholas Taleb’s 2007 best selling book The Black Swan: The Impact of the Highly Improbable. That’s because, for many economists and financial strategists, black swans are quintessential examples of faulty presumptions of impossibility.

Okay … so what do we mean by faulty presumptions of impossibility? Well, for centuries, Europeans assumed that all swans are white because the only swans they ever saw were white. But some free thinkers warned that, although highly improbable, it might nevertheless be possible for black swans to exist in some remote corner of the world. And lo and behold, one famous day in 1697, Dutch explorer Willem de Vlamingh discovered a pair of black swans in the New Holland region of coastal Australia.

Ever since then, the black swan has assumed an important meaning in the minds of financial market strategists. Namely, they represent events that have never previously happened, and thus are often falsely assumed to be incapable of happening … until they actually do happen. The simultaneous collapse of all global markets and economies last year, for instance, represented one such black swan event.

Some Say Black, Some Say White

Or was it truly a black swan occurrence? Bernanke would have us believe so; he has repeatedly described the great bank bailout of 2008 as an extraordinarily rare event, one not required since the bank failures that followed the great Wall Street stock market crash of 1929.

One problem with Bernanke’s assertion, though, is that such collapses actually tend to occur distressingly often. After all, the Dow Jones Industrial Average did decline by over 45% between 1973 and 1974; it later declined by over 22% on a single “Black Monday” day in October 1987. It subsequently declined by approximately 27% between 2001 and 2002; considering the frequency of these declines, one might expect such crashes to come along once every decade or so!

In fact, in his 1954 classic The Great Crash of 1929, Harvard University economist John Kenneth Galbraith noted that “the memory of the financial mind lasts about ten years.” Galbraith explained that, in his opinion, it takes ten years for the painful memories of each market crash to fade away in the minds of investors; thus, every decade or so, they can be expected to become irrationally exuberant and to begin to assume reckless levels of risk. In other words, Galbraith believed that we are doomed to experience crashes relatively frequently because human nature leads us to forget our hard-learned lessons during such time spans.

Furthermore, recent developments in the financial markets, in technology, and in society have facilitated the rapid spread of global market panics. The emergence of our 24/7 internet based news media, for instance, has made it possible for terrifying rumors and distressing news to spread across the globe in the blink of an eye.

And the use of computerized trading systems has made it possible for hundreds of billions of dollars to be yanked out of entire industries, nations, and global regions in a matter of minutes. According to Galbraith, then, global market collapses should not necessarily be interpreted as once-in-a-lifetime black swan events; instead, they should be expected to occur as regularly as the American decennial census.

He Still Deserves It!

So do we believe that Chairman Bernanke doesn’t deserve the Person of the Year award? We certainly wouldn’t go that far; in fact, even if one believes that Chairman Bernanke should have been better prepared to anticipate and respond to the collapse of our financial markets, one cannot help but admire the manner in which he ignored our political maelstrom and plowed ahead with his plan to flood our economy with liquidity.

Nevertheless, true economic prosperity will only arrive when investors regain confidence that Bernanke is prepared to manage any unanticipated problems that may occur in the future. Whether these problems are truly black swans, or whether they are foreseeable and are thus amenable to principles of enterprise risk management, our Person of the Year must nevertheless be prepared to manage another challenging year in 2010.

Four More Years: Bernanke Returns!

For a brief moment this past week, the American public glanced away from the economy’s unprecedented run of volatility and took pleasure from the insight that the biggest news story actually involved continuity.

In other words, a lack of change was the big story this week. But what exactly was this story? Were the New York Yankees winning yet again? Or was there yet another ghastly rumor in the Michael Jackson case?

Well, yes … and yes. The Yankees and the Jackson case just keep chugging along. But those stories of continuity don’t impact our economy, at least not in any dramatic manner. The reappointment of Ben Bernanke as Chairman of the Federal Reserve Bank of the United States, though, created quite a stir.

American Socialism

In retrospect, the buzz surrounding Ben’s reappointment should not have surprised any one; after all, the existence of an American national bank has itself been a controversial news story for decades, even centuries. Initially proposed by Alexander Hamilton to pay off the fledgling nation’s Revolutionary War debt, the short lived First Bank of the United States was dissolved soon after achieving this goal in 1811.

Just one year later, though, America entered the War of 1812 and began incurring a brand new pile of war debt. The Second Bank of the United States was then established to pay it off yet again; then, after achieving this goal, President Andrew Jackson dissolved the Second Bank during the 1830s. And after banking titan J.P. Morgan played a huge role in stabilizing the American financial system during the Great Panic of 1907, Congress decided to (finally!) create a permanent Federal Reserve Bank in 1913.

We’ve lived with this modern “Fed” ever since 1913. Nevertheless, why have Americans historically felt such ambivalence about creating a permanent national bank? Apparently, certain conservative politicians and citizens have always regarded national banks as socialist threats to capitalism and liberty. In fact, many of the arguments being made today against national health care echo the arguments made throughout history against national banks.

A Long Shot

At one time, the continued existence of any national bank seemed like a long shot; similarly, Bernanke’s reappointment at the Fed recently seemed like a long shot as well. Ben was, after all, first appointed by President Bush; President Obama was strongly rumored to favor chief economic advisor Larry Summers instead.

But Bernanke aggressively flooded the American economy with capital and slashed interest rates during the economic meltdown of 2008, decisions that pleased the Obama administration. His explanation? According to Bernanke, “I was not going to be the Federal Reserve chairman who presided over the second Great Depression.”

A laudable sentiment, without doubt. But there are actually two distinct approaches to avoid presiding over a depression: one is to prevent its occurrence entirely, and the other is to delay it until someone else assumes command. Perhaps Obama reappointed Bernanke in order to eliminate any possibility that Ben was selecting the latter option!

Remember Greenspan?

Bernanke, of course, is not the first Federal Reserve Chair to resort to boosting liquidity during times of economic crisis. His predecessor, Alan Greenspan, did so time and time again in response to market declines, a currency crisis, a terrorist attack, and various other incidents during his long tenure. In fact, Greenspan’s actions appeared to preserve the longest run of economic prosperity in modern American history. So who could argue with his track record?

Well, Alan himself could … and in fact has done so. He went on the record to acknowledge that his actions might have contributed to the inflation of economic bubbles that “popped” after he retired from office, though he has also defended himself against his harshest critics. By flooding markets with investment capital, Greenspan asserts that he ensured the continued flow of healthy economic activity during his tenure. Nevertheless, he also agrees that he may have enabled the stock market, real estate, and other dysfunctional bubbles to flourish as well.

Time will tell whether Bernanke’s strategy will lead to a similar fate. There is, sadly, a distinct possibility that today’s tentative “green shoots” of economic recovery are actually only temporary bubbles that may eventually collapse into the throes of a “double dip” recession.

The Nature of Risk

A double dip recession is a depressing prediction, isn’t it? But it isn’t an inevitable one; after all, many different unique factors contributed to the collapse of the world’s markets in 2008. For instance, oil soared to $147 per barrel. The Afghani and Iraqi wars drained America’s wealth. And global warming appeared to reach a tipping point, sparking hurricanes, tsunamis, droughts, and other catastrophically costly natural events.

Greenspan and Bernanke argue that the likelihood of a second Great Depression would have been much higher if not for their actions. But if they only succeeded in delaying (as opposed to preventing) future economic collapses, then the costs of their decisions may prove to have exceeded their benefits. In other words, all of their efforts may have gone (or may yet go) for naught.

The nature of risk is a function of balancing the possibility that crises may occur against their potential effects if they cannot be avoided. With this in mind, only time will tell whether Bernanke and Greenspan truly eliminated the possibility of a Second Great Depression, or instead simply delayed it. Given Obama’s reappointment decision, though, we may still have Ben around to thank – or blame – when we learn the answer to that fateful question.