This was written on 10/15/2010
Bernanke gave a speech today in which he outlined additional steps the Fed is thinking about taking to boost the economy. The stock market is probably reacting in the appropriate way (highly uncertain - down and sideways) - because there is nothing the Fed can do anymore to boost the economy in a big or sustainable way. The Keynesian economists think they can - but the reality is that they can't and the Wall Street traders apparently are beginning to realize that.
This website explains why the Keynesians can't - and that explanation is why the economy won't hold up.
A summary of my explanation (followed by actual comments about Bernanke's speech - I indicate down below where that transition happens) is as follows.
The Kondratieff wave is going to be there - no matter what. It can be stretched to the limit - and that is what has been happening - but it will never go away (in a capitalistic society).
The transition from the stagnation phase of the Kondratieff wave (1970's in our case) to the plateau phase (1980's in our case, which was then stretched out to 2000 by the enforcement of the law against recessions) involves high interest rates and a recession (which happened in late 1970's/early 1980's) if the currency is disconnected from precious metals early in the stagnation phase (as was done in our case - Nixon in 1971). The disconnection is never a good thing, but it seems like the expedient thing to do at the time in most cases, and in most cases, it (therefore) happens. If it happens, the stagnation phase gets extended by a few years and the result is even higher inflation than at the beginning of the stagnation phase, high interest rates, and a(nother) recession. We had that.
The common belief is that Paul Volcker saved us from that - actually (as noted on this website), he only cooperated with what would have happened anyway. (If people would know about the Kondratieff wave in detail, they would realize that - but most people in the West do not know about the Kondratieff wave in detail at all.)
And then when the Kondratieff wave gets into the plateau phase, things settle back down again, disinflation (i.e., inflation that is going down) sets in, economic growth resumes, though at a lower level than during the growth phase and going steadily, though not continuously, lower as the plateau phase progresses (this is key!), and the stock market proceeds to go up more than it would have during the growth phase (new money goes into the stock market, rather than into consumer prices - this is key!).
So what did the Fed do come the stock market crash of 1987? Nothing more than cooperate with the Kondratieff wave and take advantage of it in terms of where it was at the time; the central bank really could not have done otherwise. The transition from the plateau phase to the depression phase happens when the stock market goes high enough that it can't sustain itself anymore - so it comes back down - and the disinflation of the plateau phase has reached a point where inflation has gone so low that it transitions into outright deflation. The combination of a falling stock market and inflation having transitioned to deflation results in a deflationary depression, which then (normally, in the past) runs its course over a few years and cleans out the imbalances in the system that have accumulated during the Kondratieff wave so that the next Kondratieff wave (i.e., the growth phase of that one) can begin.
What happened this time is that when the economy wanted to transition from the plateau phase to the depression phase (the stock market crash of 1987), the Fed pumped more money into the system (the first time that has ever happened at that point in the Kondratieff wave, as far as I can tell) and since the system had not actually transitioned into the depression phase yet - in other words, the mentality of the people was still in terms of the plateau phase - the money-pumping worked, the people stayed in the plateau phase mentality and the stock market went up even more (more than it could have if there had been no intervention).
So, in effect, the Fed extended the plateau phase of the Kondratieff wave beyond where it would have otherwise ended.
One of the results was that consumer demand continued and even accelerated (it turned into, by the end of the 1990's, what I then called a "spend-a-thon"), thus interrupting the overall disinflationary trend and causing that disinflationary trend to be stretched out over a much longer period of time.
But that all could only go so far - because a stock market can't go up forever. And, in fact, this one didn't - it went up as far as it could, going exponential in the late 1990's (topped out in early 2000), and then it came back down (as exponentials always inevitably do, there is nothing anyone can do about that).
That was the transition from the plateau phase to the depression phase of our Kondratieff wave.
But the Fed fought even that - and so the beginning of the end of the disinflationary trend did not even show up until 2003, as noted by Bernanke in his speech today.
At that point, the Fed, having been worried for decades about inflation (unnecessarily so once the plateau phase of the Kondratieff wave kicked in in the early 1980's - but Keynesians don't believe in the Kondratieff wave, see this website), started worrying about deflation (as noted by Bernanke in his speech).
That was a legitimate worry - but there is simply nothing the Fed can do about it in the long run. They can postpone it - and they have been doing that - but they can't ultimately stop it from happening.
The simple reality is that the Kondratieff wave can't be overridden (as I note at the top of the link "Why my model works" already, just two links after the home page link on this website, the first link being a statement of my overall premise) - and the tail end of the Kondratieff wave involves deflation and depression. In fact, the very transition through the later phases of the Kondratieff wave involves high consumer price inflation going to low consumer price inflation eventually going to zero consumer price inflation (which we have had a whiff of already, despite the Fed's best efforts) followed by negative consumer price inflation, i.e., deflation.
The Fed has been trying to avoid the deflation phase with all its might in recent years - but the reality is that the phase can't be avoided forever and we are inexorably, slowly heading toward it. We have been in the transition phase since 2003 in the meantime - but inflation does still keep going down (on average) over the course of time, as predicted by the Kondratieff wave (actually as predicted by me, taking modern manipulations into account), and we effectively went below zero for a short period of time already during the downturn of the previous couple of years.
Things have come back up some during the recovery, but it is only a temporary, partial recovery, and there is nothing the Fed can (ultimately) do about that - note how the Fed keeps having to admit, during the past couple of years, that the economy is not responding as well to its efforts as it hoped and anticipated (a development that I predicted, it did not surprise me one bit) - the economy is going to continue to perform on a sub-par basis until the combination of the damage done by the initial downturn and the continued build-up of imbalances as a result of the momentum from the previous better times (as a result of the mentality of those times continuing to be in place for now) will overwhelm the economy and we will go into a big new downturn. That is inevitable, it is only a matter of time.
And when we get to that point, the Fed will be powerless to stop it - the initial overwhelming of the Fed happened in the fall of 2008, the final overwhelming of the Fed will happen when the time that I just described comes.
And it will happen because we are still in an overall downward trend in consumer price inflation (taking everything into account, including housing, which is important because more than half of Americans live in a home that they have bought) and that trend is ultimately unavoidable, it will continue - and the stock market will also not stay up, it is in a bear market bounce (may just have had a double-top with the April 26 high, so we may well finally now be in the true downtrend going into the next downturn) and ALL bear market bounces are completely retraced to the downside and then some, in other words, the stock market will come back down, and when it does, we will have the conditions of negative inflation and a declining stock market that always accompany the transition into the deflationary depression of the Kondratieff wave - with the caveat this time that we will have been in the depression phase of the current Kondratieff wave for years already, since 2000, and so we have had a build-up of imbalances in the current Kondratieff wave that is unprecedented (due to the enforcement of the law against recessions), and so when the deflationary depression hits this time, it will be the mother of all deflationary depressions in modern times. In fact, the closest precedent we have is nearly 300 years ago - the Mississippi and South Sea bubbles of the 1720's - and that is why I have been predicting the biggest bear market in nearly 300 years.
And now on to the comments about Bernanke's speech today -
Bernanke says that "Sustained expansion must ultimately be driven by growth in private final demand, including consumer spending, business and residential investment, and net exports. That handoff is currently under way."
True, that handoff is underway - but I would expect such a development, at least partially, at the top of a big bear market bounce, which is where we are at now. Precisely because it is the top of a bear market bounce, that handoff is not sustainable.
"However, with growth in private final demand having so far proved relatively modest, overall economic growth has been proceeding at a pace that is less vigorous than we would like. "
That would, indeed, be the case at this point in the cycle!
"In particular, consumer spending has been inhibited by the painfully slow recovery in the labor market, which has restrained growth in wage income and has raised uncertainty about job security and employment prospects. Since June, private-sector employers have added, on net, an average of only about 85,000 workers per month--not enough to bring the unemployment rate down significantly."
Yep! And that is exactly what I would expect at this point in the cycle - and that is part of why the economic recovery is not sustainable.
"Consumer spending in the quarters ahead will depend importantly on the pace of job creation but also on households' ability to repair their financial positions. Some progress is being made on this front. Saving rates are up noticeably from pre-crisis levels, and household assets have risen, on net, over recent quarters, while debt and debt service payments have declined markedly relative to income."
True - but I would expect a partial easing in a partial recovery.
"Together with expected further easing in credit terms and conditions offered by lenders, stronger balance sheets should eventually provide households the confidence and the wherewithal to increase their pace of spending."
This is typical utterly conventional Keynesian thinking. Most of America is middle-class - and dependent on a job, ultimately, and the middle class knows it. So further easing of credit terms and conditions, combined with stronger personal balance sheets, is not going to solve the problem. It is necessary, but not sufficient. People will not feel confident until the jobs picture improves (it won't). People were willing to spend on credit before (in early 2008 and before), including using their houses as ATM's, because although we were in the depression phase of the Kondratieff wave already (since 2000), people didn't know it because the government had kept the economy going and so people still felt confident that everything was OK, they were still enjoying the good times, at least as perceived by them, and so they were very willing to spend money. That all changed in the fall of 2008 - when they go hit with the worst economic downturn since W.W.II (as a result of the economy being held up for too long already by then - thus resulting in a particularly bad downturn), which spooked them and nothing has been the same since. Nothing will be the same - because the conditions that were before simply can't come back, even if the Fed provides conducive background parameters.
"That said, progress has been and is likely to be uneven, as the process of balance sheet repair remains impeded to some extent by elevated unemployment, lower home values, and limited ability to refinance existing mortgages"
That is exactly what I would expect at this point in the cycle.
"Household finances and attitudes also have an important influence on the housing market, which has remained depressed, notwithstanding reduced house prices and record-low mortgage rates. The overhang of foreclosed properties and vacant homes remains a significant drag on house prices and residential investment. "
Yep. And not only is it exactly what I would expect at this point in the cycle in a society that operates the way ours does (in terms of housing and finance), it is exactly what I would expect to see based on the fact that the housing market ran out of buyers (at the margin) a few years ago. Since that is the case, the market can't recover (and it won't) - despite the Fed working successfully to provide the lowest mortgage rates ever. People who already have a house don't need another one - at least not to a sufficient extent (in terms of trade-ups) to keep the housing market going well (and the rest of the market was sucked dry during the federal tax incentives earlier this year when young people who had not been in the market during the boom years a few years ago, but had graduated from college in the meantime and were among the lucky ones to find jobs, bought houses; since then, the housing market has been effectively dead).
Bernanke then talks about business spending having slowed back down - I would expect that in a partial recovery once the CEO's realize that the recovery is not as robust as they expected it to be.
And then he says " Investment in nonresidential structures continues to contract, reflecting stringent financing conditions and high vacancy rates for commercial real estate."
I would expect exactly this condition during a partial recovery at the very end of a very long economic growth period just before the economy as a whole goes into a big downturn (which it will do in part because it can't overcome the high vacancy rates in commercial real estate; in other words, efficiency of use just can't be achieved in that sector again).
"The availability of credit to finance investment and expand business operations remains quite uneven."
Yep, that is exactly what I would expect at this point in the cycle! (It is what happens in a bear market bounce, a partial recovery.)
"Generally speaking, large firms in good financial condition can obtain credit in capital markets easily and on favorable terms. Larger firms also hold considerable amounts of cash on their balance sheets."
Yep - but they don't have the majority of the employment (even though they are large companies).
"By contrast, surveys and anecdotes indicate that bank-dependent smaller firms continue to face significantly greater problems in obtaining credit, reflecting in part weaker balance sheets and income prospects that limit their ability to qualify for loans as well as tight lending standards and terms on the part of banks."
Yep - and that is where the jobs are. That is why this is a jobless recovery and will, at least more-or-less, remain so.
"The Federal Reserve and other banking regulators have been making significant efforts to improve the credit environment for small businesses, and we have seen some positive signs. In particular, banks are no longer tightening lending standards and terms and are reportedly becoming more proactive in seeking out creditworthy borrowers."
True - but "no longer tightening" is not the same as "loosening" (in other words, it is necessary, but not sufficient), and "becoming more proactive in seeking out creditworthy borrowers" is not so important when there are fewer and fewer creditworthy borrowers available and the ones who are available are reluctant to borrow (because the economy is so tentative and weak).
"Although the pace of recovery has slowed in recent months and is likely to continue to be fairly modest in the near term, the preconditions for a pickup in growth next year remain in place."
That is only true for the time being. Precisely because the growth is so slow, there is no way the system is going to hold up because people will continue to remain cautious in the slow economy and so eventually, they will simply lose patience and cut back again to try to save their own skins.
"Stronger household finances, a further easing of credit conditions, and pent-up demand for consumer durable goods should all contribute to a somewhat faster pace of household spending."
Nope. This country is middle-class - and as long as middle-class people perceive the economy to be bad, they will be cautious in their spending. They were fine until the downturn of 2008 - but everything changed then.
"Similarly, business investment in equipment and software should grow at a reasonably rapid pace next year, driven by rising sales, an ongoing need to replace obsolete or worn-out equipment, strong corporate balance sheets, and low financing costs."
True - but as long as the housing market does not recover, that will not matter in the long run.
"In the public sector, the tax receipts of state and local governments have started to recover, which should allow their spending to stabilize gradually."
I expected the tax receipts to turn up somewhat at the top of the bear market bounce - but since it is just a bear market bounce, that improvement won't hold up. When it doesn't, the public sector will be in trouble again.
"The contribution of federal fiscal stimulus to overall growth is expected to decline steadily over coming quarters but not so quickly as to derail the recovery."
This is not really relevant - as long as one is spending huge amounts of money that one does not have to try to keep an economy going, the recovery is not sustainable. And our national debt is already past the knee of the exponential (it went past the knee a couple of years or so ago) and going up at a horrendous rate in the meantime, which will eventually derail the recovery anyway if nothing else does in the meantime.
"Continued solid expansion among the economies of our trading partners should also help to support foreign sales and growth in the United States."
Most of those places are as deeply in debt as we are, if not even more so - so ultimately, this statement is simply not relevant, since we are at the very late stage of a very long economic up-cycle.
"Although output growth should be somewhat stronger in 2011 than it has been recently, growth next year seems unlikely to be much above its longer-term trend. If so, then net job creation may not exceed by much the increase in the size of the labor force, implying that the unemployment rate will decline only slowly. That prospect is of central concern to economic policymakers, because high rates of unemployment--especially longer-term unemployment--impose a very heavy burden on the unemployed and their families. More broadly, prolonged high unemployment would pose a risk to consumer spending and hence to the sustainability of the recovery."
Unemployment will, indeed, not come down quickly, actually probably not at all, and that is going to be the main drag on the economy because this economy consists mostly of middle-class people. That is the main reason why I say that the economy won't recover. The Fed is very right to be worried about it (that is their job) - but there is not much that they are going to be able to do about it.
Then Bernanke turns to inflation.
"Generally speaking, measures of underlying inflation have been trending downward."
Yep - as noted already, that is exactly what I would expect to see at this stage of the cycle. Inflation is now only about 1.1% - clearly at a level that is too low for the Fed to be comfortable with it (but a level that does not surprise me one bit, given where we are at in the cycle).
"The decline in underlying inflation importantly reflects the extent to which cost pressures have been restrained by substantial slack in the utilization of productive resources."
Resource utilization goes down over the course of time in the later stages of the Kondratieff wave as the economy matures - and so it is no surprise to me that resource utilization has been going down and is as low as it is in the meantime. But that is a concept that Keynesians can't relate to at all - and so they just keep hoping, and expecting, that resource utilization will go back up (a lot). That is a pipe dream - it won't happen.
Bernanke then goes into a fairly technical discussion, which I won't comment on here, but then says
"The longer-run inflation projections in the SEP indicate that FOMC participants generally judge the mandate-consistent inflation rate to be about 2 percent or a bit below. In contrast, as I noted earlier, recent readings on underlying inflation have been approximately 1 percent. Thus, in effect, inflation is running at rates that are too low relative to the levels that the Committee judges to be most consistent with the Federal Reserve's dual mandate in the longer run. In particular, at current rates of inflation, the constraint imposed by the zero lower bound on nominal interest rates is too tight (the short-term real interest rate is too high, given the state of the economy), and the risk of deflation is higher than desirable." And he even then says that "... it is reasonable to forecast that underlying inflation - setting aside the inevitable short-run volatility - will be less than the mandate-consistent inflation rate for some time."
That is exactly right! And is exactly what my model predicts for this stage of the cycle - as noted above, we are getting closer and closer to the point where deflation will become the long-term experience, despite the Fed's efforts.
And then he goes back to unemployment and says the following
"Nonetheless, with an actual unemployment rate of nearly 10 percent, unemployment is clearly too high relative to estimates of its sustainable rate. Moreover, with output growth over the next year expected to be only modestly above its longer-term trend, high unemployment is currently forecast to persist for some time."
Yes, the unemployment rate is clearly too high relative to the mandate for full employment. And, yes, high unemployment is likely to persist. In fact, it is likely not to come back down again for a long time to come - because, in fact, we are in the beginning of the long-term downturn and so unemployment will remain high (and, ultimately, go much higher) and inflation will remain below where the Fed wants it; it will, in fact, eventually (probably sooner, rather than later - at this point) turn into outright across-the-board deflation and completely undermine the efforts of the Fed.
Then he goes into monetary policy issues - and promptly says that although there would appear to be a case for further Fed action, the Fed is, in fact, hampered by the limitations of monetary policy at this point because interest rates are so close to zero (which is, in fact, ultimately what stops every central bank in its tracks!).
He even points out that the Fed reduced its target interest rate to nearly zero nearly two years ago (and look what the Fed has to show for it - not nearly as much as they would like). He points out that, in effect, non-conventional policies are all that are left (he is very right) - and that those all have costs and limitations that must be very carefully taken into account (very true!). In effect, he is saying that the Fed must now resort to emergency efforts that are not normally used precisely because they are so difficult to handle - in other words, the Fed is between a rock and a hard place (just as I predicted years ago that it would eventually be)!
He then even points out that, in effect, the Fed has no good options left (no kidding - that is the way it is at the very end of a very long economic boom!) - and even, in effect, says right at the end of the speech that the only option the Fed really has left is to communicate very effectively with the public in order to convince the public to keep doing what the Fed wants it to do so the economy will stay on an even keel, but also says (in his conclusion) that "there are clearly many challenges in communicating and conducting monetary policy in a low-inflation environment, including the uncertainties associated with the use of nonconventional policy tools." In other words, he is saying that it will be very, very, very difficult (and he is quite right!).
Then he launches into the usual statements that end every major Fed speech - that "despite these challenges, the Federal Reserve remains committed to pursuing policies that promote our dual objectives of maximum employment and price stability."
The Fed says that every time - but doing so is getting harder and harder.
"In particular, the FOMC is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate."
The Fed also usually says this - but the "accommodation" is having less and less effect, really no effect at all in recent times (actually, less than zero effect in recent times). And I think people are beginning to realize that.
"Of course, in considering possible further actions, the FOMC will take account of the potential costs and risks of nonconventional policies,"
Of course it has to say that! Say anything at all to make even a negative situation sound positive. The Fed must keep the people in the public thinking positively, even if the conditions don't warrant it at all and people who fall for it will be very sorry in the end.
"and, as always, the Committee's actions are contingent on incoming information about the economic outlook and financial conditions"
Of course they are - always. This is just a statement that in part indicates the obvious and in part is intended to convey a sense that the Fed is on top of things and is monitoring things successfully and will adjust as needed. The problem is that the Fed is not on top of things anymore and the monitoring that they are doing is therefore increasingly irrelevant and any adjustments that they do are likely to be increasingly ineffective, or even pointless.
My concern is that too many people will realize that too late and very much pay the price for that late realization.