Special Fed Comments 2008

SPECIAL FED COMMENTS 2008Last entry: 1.22.08

The past few weeks the market has faced a lot of turmoil, with media hype directed towards the Fed and its Chairman Bernanke not telegraphing a consistent message. We disagree with the diagnosis. This fed has been if anything overly consistent relative to its beliefs, and we would say that the fallacy of the situation is related more to the beliefs than how the message gets out. Yesterdays (1/20/08) NY Times magazine interview of Bernanke is must reading for anyone involved in the markets. In it is outlined Bernanke’s beliefs and to me the core reasons why he will not be able to provide a long-term answer to the meltdown.

Some important comments to us from the interview:

1. Bernanke is an academic and has written some of the seminal papers on: A) how to prevent market panics; B) how to gauge the effect of Fed moves on stock-market prices; and C) how to improve communications between the Fed and the Public.
2. Bernanke believes that the Fed should tailor policy to conditions as they are forecast, not just as they are.
3. Bernanke believes in the theory of ‘rational expectations’ which posits that for monetary policy to work, the market and the Fed must each have a clear idea of where the other is going. I.e. Investors have to watch the Fed, but the Fed also has to take the pulse of investors.
4. The Fed has a term for the economy for the last 25 years, ‘The Great Moderation’ , growth cycles have been evened out, inflation has been kept low, and the US has only been in recession for 16 months in that whole period. Quoting the article, ‘perhaps the ‘Great Moderation’ has been a result of good luck or to improved management skill . Bernanke has written that it is something else. He sees it in large part because of better monetary policies. He says that central bankers have finally learned how to guide economies, not with mystique, but with economic science. If that is so, we will not need a wizard behind the curtain anymore, only intelligent engineers who can steer markets to the promised land of rational expectations.’

Our take on all this is: Bernanke builds a strong case for creating bubbles, let everyone know what you are doing and going to do, and create a no-consequence investment climate. As to ‘The Great Moderation’ we believe this 25 year period is probably just an interlude between downturn periods in the long cycle. Also many years experience with sophisticated computer models has taught us that the more macro the model, the bigger the miss when it happens.