Former Fed Chair Ben “Great Recession” Bernanke was interviewed on CNBC this week to promote his new book 21st Century Monetary Policy: Federal Reserve from the Great Inflation to COVID-19.
We doubt his book will discuss his horrendous track record of “managing” and predicting the economy, which we detailed here and here. That includes when he said in early 2008, after the Great Recession he helped cause had already begun, that “the Federal Reserve is not currently forecasting a recession”. Then in June 2008, seven months into the Great Recession, he said “the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”
Why do people listen to this former bureaucrat? We didn’t listen to Politburo members who tried to centrally plan the Soviet Union’s economy.
Surprise: Bernanke Blames Inflation On Covid, Not The Fed
As expected for a typical Fed bureaucrat, Bernanke blames the highest inflation in 40 years solely on supply chain “shocks” that happened due to covid, saying “the pandemic has snarled supply chains around the world that has helped drive up prices. The Fed believed in the middle of 2021 that these factors would likely solve themselves over time that in other words that supply shocks were quote ‘transitory’ and so that they didn’t need to respond to the early stages of inflation because it was going to go away by itself.”
He chose to ignore the fact that the Fed drove a 40% increase in the money supply in reaction to the covid stock market crash, which is more than double the money supply increases in response to prior recessions, as shown below.
Regarding the Fed being way behind the curve on “fighting” the inflation they created by exploding the money supply, at least Bernanke admits the Fed made a colossal mistake by delaying raising rates, because Fed Chair Powell didn’t want to “shock the market”.
Bernanke admitted: “I think, in retrospect, yes, it was a mistake, and I think they agree it was a mistake. There were a number of reasons for it. One of the reasons was that they wanted not to shock the market. They wanted to avoid, Jay Powell was on my board during the taper tantrum in 2013 which was a very unpleasant experience, he wanted to avoid that kind of thing by giving people as much warning as possible. And so that gradualism was one of several reasons why the Fed didn’t respond more quickly to the inflationary pressure in the middle of 2021.”
Bernanke Doesn’t See A Recession Coming, But He’s The Last Person To Ask
Bernanke stated the simple truth that “the more the Fed has to tighten in order to get inflation down, the bigger the chance of a recession and the more severe it will be.” He admits that the Fed plans to drive down stock and housing prices, saying “there’s a lot of support for the fact that the Fed is tightening now even though obviously we see the effects in markets, you know, we’ll see the effects in house prices, etc.”
As shown below, the Chicago Fed's National Financial Conditions Index is at negative 0.23, which means the Fed has a lot of work to do to keep whatever credibility it has and tighten financial conditions enough to slow the inflation they created. This Index provides a weekly update on US financial conditions in money markets, debt and equity markets and the traditional and "shadow" banking systems. Positive values of this Index indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.
Nevertheless, Bernanke doesn’t think the Fed will cause a recession because the economy is so “strong”, saying “I guess that I still tend to believe that some of these forces pushing up inflation like the supply chains…will at least stabilize and begin to moderate sometime during this year which would mean that inflation will come down to some extent, not saying by itself, but without the Fed’s direct intervention. If that happens, the Fed would have to raise rates perhaps moderately above neutral. When they do that, they’ll slow demand. But as Jay Powell has pointed out, the economy is pretty strong. We’re not going into recession as often is the case with a troubled economy. In fact, the underlying economy as we recover from the pandemic is quite strong. We have a very strong labor market, for example, we have a strong financial system, we have strong balance sheets. So if the inflation slows as I expect it ultimately will, although I’ve been disappointed about how slow that process is, than the Fed should not have to raise rates, you know, too far and what we would get that would be a slowing of the economy, maybe even a stall, but not a severe recession.”
He goes on to say that inflationary expectations are still contained, so it’s not a crisis situation yet: “The severe recession would only come if these other factors simply do not cooperate and in particular, the thing the thing people should watch most closely is inflation expectations. If inflation expectations as measured by breakevens in the Inflation-Protected and Securities market, as measured by surveys and so on, begin to move up in a significant way that people have lost confidence in the credibility of the Fed, the Fed will have to react much more strongly and the effects in the economy will be much more deleterious. Today, most indicators suggests that people are still pretty confident that the Fed or maybe some combination of the Fed and the end of the pandemic will lead to more normal inflation in the future.”
Bernanke is correct that long-term inflation expectations have not yet gotten out of control, as expected inflation over the next decade is 2.71%, as shown below. But this is above the Fed’s arbitrary 2% target and the Fed needs to fulfill its promise to raise rates aggressive to try to bring inflation down in order for inflationary expectations to not get out of control.
Recession Warnings Are Mounting
We recently discussed recessionary warnings like rising initial unemployment claims and junk bond yield spreads. There are other indicators warning of recession, including the University of Michigan Consumer Sentiment Index, which is clearly at recessionary levels, as shown below.
In addition, Real Personal Income is now down 17.1% versus last year, by far the largest decline in over 60 years, as shown below.
A relatively new but highly accurate economic indicator is the Brave-Butters-Kelley Coincident Index (BBK Coincident Index), which is 99% accurate in aligning with historical US recessions and expansions. As of April 28, this Index was at 0.46, still above the -1 threshold that signals the economy is in a recession. However, the BBK Leading Index fell to -1.57, below the -1 threshold that signals with 86% accuracy that a recession is likely to start within eight months.
Bernanke Doesn’t Understand Basic Economics, Which Is Why He Favors Higher Capital Gains Taxes And Bitcoin Regulations
Bernanke proves he does not understand basic economics in this comment: “Well, in theory, the fiscal authorities could play a role. That is, this is what modern monetary theory says, you know, that by raising taxes and cutting spending and reducing aggregate demand and so on, the fiscal authorities could play the same kind of role as the Fed which basically reduce demand and get inflation down.”
Inflation (rising prices) is caused by excess money relative to the supply of goods and services. If the US government raised taxes, it would just transfer money from the people to the government to spend, which would lower overall living standards but wouldn’t necessarily impact “aggregate demand”. If the government cut spending, then it would reduce the amount of capital the government would have to borrow, which would free up more capital for investors to lend to private companies for productive investments, which would raise living standards. None of this would change the supply of money. Only the Fed and commercial banks can legally create or destroy money out of thin air.
Bernanke is in favor of raising capital gains taxes, which would harm savings and investment and lower overall living standards, as he says here: “I’m not against taxing billionaires, but I think a better way to do it would be to raise capital gains taxes.”
Lastly, like a typical central banker protecting their power to control the money supply, Bernanke subtly warns that increased government regulations of Bitcoin are likely at some point, which we agree is the key risk for Bitcoin and other cryptocurrencies: “So, one of the other risks that Bitcoin has is that it could at some point be subject to a lot more regulation and the anonymity is also at risk I think at some point. So, you know, investors in Bitcoin should be, should be aware of that.”
Implications For Investors
The Fed causes inflation and the boom and bust business cycle, yet they always place the blame on others, like “supply chains”. They are fortunate that inflationary expectations have not gotten out of control yet, but financial conditions remain very loose, so the Fed believes they have a lot of room to lower bond, housing and stock prices in order to tighten financial conditions enough to slow inflation.
While the Fed will never admit that they will cause a recession, with various leading indicators already flashing recession risk, they likely will cause another one in the coming year.
All of this has very bearish implications for asset prices, so investors should focus on identifying and profiting from BOTH bull and bear markets.
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