Which Bernanke? Whose Bubble?

Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve.  But which Bernanke are we getting?  There are at least three.

  1. The Bernanke who led the charge to rescue the US (and world’s) financial system after the Lehman-AIG collapse.  If you accept that the choice from late September was “Collapse or Rescue,” this Bernanke did a great job.
  2. The Bernanke who argued for keeping interest rates low as the housing bubble developed.  This Bernanke was part of the Greenspan Illusion – the Fed should ignore bubbles and “just clean up afterwards.”  Is that still Bernanke’s view?  Surely, he has learned from that experience.
  3. Then there is Bernanke-the-reformer.  Given #1 and #2 above, shouldn’t he be pushing hard for tough re-regulation of the financial system – particularly those dodgy parts where markets meet banking?  But is there any sign of such an agenda, even with regard to recently trampled consumers – let alone “too big to fail” financial institutions?

Most likely, we’re in for another bubble.

The Fed will keep interest rates low for the foreseeable future.  This will make sense given continued high rates of unemployment in the US economy.  But unemployment indicates average economic outcomes – high unemployment is completely consistent with some parts of the financial sector expanding at record rates: this is part of the two-track story.

The big banks have access to large amounts of Fed-provided funding at very low rates.  We’ll see this reflected in speculative market activities (think oil).

We’ll also see this in global capital flows (i.e., gross flows, perhaps also net flows – but the new global imbalances may not be so obvious in the pattern of current account surpluses/deficits around the world).  The US is increasingly a cheap funding environment, if you are a big player (definition: anyone regarded as an important client by Goldman).  Rates now begin to rise in emerging markets, as their economies turn around.  The Asia story will be compelling fundamentals and a great carry trade (borrow cheaply in dollars, lend at higher rates in Asian currencies) – and the exchange rate risk is for appreciation against the dollar.

Everyone involved knows this is unsustainable, but also that it can last for a while – and they can get out before everyone else.  Or, alternatively, that – as major financial players – they can’t afford to sit on the sidelines (talk to Chuck Prince: what has changed, in ideology, policies, and people at the top since his day?).

Presumably, commodity prices also get dragged up – or perhaps they jump up in anticipation of the Coming Asian Boom?  Now this might lead Asian central banks to tighten, but probably not if these economies can continue to keep wage costs under control.  And it might lead the Fed to tighten, but probably not as the mantra of focusing on “core inflation” (without food and energy prices) remains intact – however anachronistic it may seem to the rest of us.  It’s hard to see Bernanke #2 doing anything different, except perhaps at inconsequential margins. 

So then we really bubble – and perhaps we even mistake it for a boom.

When the Big Crash comes, there’ll be another moment of decision: “Collapse or Rescue.”  And we know what Bernanke #1 will do.  Which is, of course, why this administration is reappointing him – and not seriously reregulating big finance.

By Simon Johnson

34 thoughts on “Which Bernanke? Whose Bubble?

  1. I can only conclude that nothing of substance will be done to protect Main Street from Wall Street, to clawback the ill-gotten gains from those in finance who created the bubble, and that it does not pay to play by any sense of rules or ethics.

    As such, why is it not rational to tune this all out and focus on wheather Michael Jackson’s doctor will be convicted of murder?

    I do not believe there is any credible plan or leadership at present that can address any of the issues identified in this blog on the matter of Finance and perhaps Healthcare.

  2. We need to quickly establish best answers for Bernanke #2&3 questions. Should we have an independent study to identify causes of our problem and regulations required? Maybe some super Elliott Ness? Possibly Tippy Golden may care to comment?

  3. Maybe our housewives will concern themselves with the carry trade the way Japanese wives did.

  4. Everyone involved knows this is unsustainable, but also that it can last for a while – and they can get out before everyone else.

    Gotta love the herd mentality.

  5. It seems very likely that China will retool its industry to manufacture goods and services for China, possibly very soon now, which will change the entire situation. The US and much of American industry is living off substantial subsidies from China. When China and other nations stop accepting IOU’s from the US, the dollar will crash and major problems will develop. Easy credit from the Federal Reserve under Ben Bernanke will not magically recreate missing factories or restore research and development skills unwisely outsourced to foreign nations. More likely it will translate into high inflation.

    It remains the case that the US should:

    1. negotiate a phased revaluation of the yuan over a few year period of time to minimize the disruption to both the US, China, and the world from the inevitable adjustment of exchange rates.

    2. Too big has failed. Break up the giant banks. Restore meaningful competition to the banking industry and cease government subsidies for banks that make extremely bad lending decisions.

    3. Adopt a strong, more focused fiscal stimulus aimed at restoring manufacturing, research and development, and other atrophied parts of the economy.

    Opponents of the current awful policies need to emphasize that these policies are contrary to the interests, the pocket books, of over 99% of the US population, including most businesses and most wealthy people. It is in most people’s interest to stop this.


  6. But if Michael Jackson’s doctor gets charged with murder, it will send a message to the financial industry that “it does not pay to play by any sense of rules or ethics”, no?

    *That’s a joke*, because we’re Doomed.

  7. Feel free to kick my digital balls for this one, but as Dr. Johnson projected when the “Big Crash” will come, and where. Pensions? Healthcare entitlements? “More of the same” in the still-unregulated financial industry? All of the above? That’s the post I’ve been looking for since I’ve been reading this blog and it seems I’ve missed it.

  8. I agree with at least two of your points, but s’far as China’s concerned, they must lend to us, lest we don’t buy from them and they crash ‘n’ burn hard.

    Also, the copyright on your website is out-of-date.

  9. China can and should switch from manufacturing kitchen gadgets and luxury computer toys for indolent Americans to making goods for the predominantly rural population in China: small refrigerators, tractors or other tools useful for farming (I am not a rice farmer), etc. That is what revaluing the yuan means. The rural population’s “savings” in yuan are converted to real demand for goods and services and a higher standard of living.

    China has a stockpile of about $2 trillion to purchase imported commodities. Arguably, they don’t need to export for years, even if they stopped exporting completely.

    China can also do more high tech projects internally such as massive solar arrays in the Gobi and other deserts. Capturing the carbon dioxide output from coal fired factories and power plants, feeding the carbon dioxide into algae ponds, and consuming shrimp that eat the algae in the algae ponds. It is in China’s strategic interest to develop sustainable internal sources of energy to avoid being held hostage by US misadventures in the Middle East, Central Asia, or elsewhere.

    The US successfully created massive rural demand for goods and services through installment payment plans and other methods during the late nineteenth and early twentieth century. China can do the same. Why not?


  10. One is compelled to inquire if Stalin’s comment, “Gratitude is a sickness suffered by dogs”, applies to Barak Obama’s effusive, and nauseating, evaluation of Bernacke this morning. Given the Obama penchant to listen carefully to his master’s voice, one would have to think so. If ever we’ll have an image of the self-generating nature of the rot inherent in the present “system”, the coming annointing will provide it.

  11. “The big banks have access to large amounts of Fed-provided funding at very low rates. We’ll see this reflected in speculative market activities (think oil).”

    Even if you could somehow reign in the speculation, it wouldn’t stop the banks from “earning” (really, stealing) money at will because their interest rate is effectively zero yet they can ask for 5+% from their “customers” (er, victims).

  12. Pablo, my own investment advisor has always said, “I don’t do timing.” I can sort of see where he is coming from (and, so far, his advice has been solid) but, taken to the extreme that makes it easy to forecast just about anything.
    Thus I agree. The opinion that would make me sit up and take notice is that where a timing prediction is offered.
    Almost worth a Post on its own? Simon/James?

  13. I apologize if everyone here is already familiar with this, but Elizabeth Warren (Congressional Oversight Panel, TARP) has written extensively on the two-income trap, the middle-class squeeze, the two-track economy that Simon mentioned in his post, etc. etc. What she writes is not my style, but nonetheless quite good.

    @Simon. I applaud you for your dispassioned and reasoned look at the Bernanke re-appointment. It seems like all I’ve been seeing on other blogs are repeated diatribes against the man and everything he’s ever done.

  14. Well, a good time would be right before the next election or right afterwards. Vacation periods are bad, as are holidays like Christmas and New Years. The summers are usually pretty slow, but things pick up again in the fall around now.

  15. Wow. Hmmm…Hadn’t thought of it that way. Cheers, John. I’m humbled. The question that lingers for me then is: Why doesn’t China make these moves? Or are they? Additionally, if the yuan is revalued by making the moves you suggest, would this put at least some of the American blue collar back to work? or is the industrial economy gone for good? Also, what affect would this have on the dollar? Weaning off their reliance on the American consumer would increasingly leave China with less reason to buy our paper, right? And more reason to sell it?

    Could this be the Big Crash Simon references at the end of this post?

    Cheers again, John.

  16. One of the guest bloggers gave a link to the following Bernacke speech in 2006:


    Chairman Ben S. Bernanke
    At the Stonier Graduate School of Banking, Washington, D.C.
    June 12, 2006
    Modern Risk Management and Banking Supervision

    If you haven’t read it, it’s worth the time. It seems to me that most of what Bernacke was boasting about at the time imploded during the next 30-odd months.

    It would be most interesting to go thru this speech, point-by-point, and make a list of the systems, sub-systems, “institutions” and so-on, and then review how these items performed during the “meltdown”.

    While there might be no one other than Bernacke at the moment (well .. seems an AFL-CIO leader has been appointed the head of the NY Fed .. so maybe there are some other Labor Leaders Obama might have in mind for this job) .. it sure seems that his vision in 2006 was of a different world than we have experienced in 2008-09.

    What has he learned? Hope someone in Congress reads this speech and makes not of it to him.

  17. re: Paul & James

    More than anything, I suppose I’m asking: Is the Big Crash inevitable? And if so, where are the greatest strains / most dangerous bubbles in the economy that could catalyze such a crash?

  18. China has not yet “pulled the plug” on subsidized exports to the US for two reasons.

    1. Inertia and resistance to change. This is almost always the case. It is like all the previous bubbles that have gone on longer than one would have thought.

    2. Chinese industry knows how to make goods and services for the US market. The US buys household gadgets, Dell laptops, and so forth. Many of these items would not sell well in rural Chine (my educated guess). A poor (by US standards) rural population has more practical and pressing needs than the US population. The rural Chinese population is more like the US rural population 100 years ago.

    Consequently, China must retool to manufacture goods and services for the (huge) rural population. Farming tools, possibly small generators, reliable small refrigerators to preserve meat, various things like this would probably be the winners. It is not just a matter of shipping the items currently in WalMart or Target to the rural Chinese population. Many of the probably won’t sell.

    China now has the factories and technical expertise to make items appropriate for the rural population that ideally should boost food production and raise the standard of living in rural China, but they do not necessarily know exactly what to make or how to market it to the Chinese population. They need to study the early history of industrial nations like the US that were once in the same boat. Very likely, they will figure it out.

    Every day the clown show in the US gives them more and more reason to reevaluate their policy, if they have not done so already, and there is pressure from the rural population for change.



  19. – nobody mentioned that China needs American food supply just as the Soviet Union did
    – if you want to know how it came about in the Soviet Union listen here – Stalin got taken in by a fraudster, famines etc. included

    – you do not need a piece of land to grow potatoes, it can be done in a barrel and the yield is quite impressive, also rabbits thrive even on a balcony

  20. Someone who claimed to be Bernanke’s neighbour once claimed on a blog that Ben religiously picked up after his dog. Two thoughts: Why do we have to pick up after Ben? Does he really have a dog? If so, could someone get a bug on its collar so we could listen in? (By court order, of course).

  21. Stephen Roach (Morgan Stanley former economist now head of Asia for them) has an interesting article on this topic in the Ft, where he opposes Bernanke’s reappointment:


    His view is that the real Bernanke is the one described in 2 and 3 in Simon’s post. I agree. We can and should improve this institution. The time for the “turnaround specialist” is past. Let’s get a “builder” in there, who has a world view that can actually leverage the considerable human resources a the Fed banks.

  22. Simon, as you know, Ben was intimately involved in the development and implementation planning of Basel II. In an Oct. 2004 speech (before I forget who, sorry, no link from my cell), Ben commented on the challenge that implementation posed, and how Citigroup was part and parcel to cross-border testing. Given the prominent role private banks such as Citi and (presumably) others played in shaping the “rules”, not to mention the laws that allowed them to develop as they have – which, by the way, taken together have only served to codify their tyrannical rule over soveriegn will – what makes you or anyone else believe theres any hope of change when it is clear as glass they are the framers of economic reality?

  23. Simon, is there any chance the new regulatory function at the Fed will actually address ethics in a meaningful way? Is there a commitment at the White House to do so? Do they have a grasp of the issues. The culture of greed is now so apparent at even the bank branch level where employees are convinced to make the most cash for themselves and to use the customer to do it. I believe this is a projection from further up the management ladder and the ordinary employee likes the money but is sort of an unwilling participant in the conflicts and compromises that must be made to get to the top of the pay charts. What brings it home is the death knell for anyone that does not play the game. So there is a whole psychology and behavioral economics game going on and without grasping that most attempts at regulation will be futile.

    On a second note, I had a brainstorm of an idea and would like to bounce it off you guys if you could contact me.

  24. I can’t think of a single instance where ethics has – successfully – been taken care off by regulatory functions

    unless there is a common idea/belief of how a decent person should behave and fear of what happens if he/she doesn’t it doesn’t work. On the village and probably club level it is the fear of being shunned that provides a powerful incentive. If you move to bigger entities you have to have something bigger. To date this something bigger has been religion. In the last century ideologies gave it a try with horrifying results – communism, nazism and – maybe – nationalism

    right now it looks to me like religions are competing heavily inter alia about whether the secular democratic state is good or bad. – if I am right about this then you can’t get at it with a few or even a lot of ethics rules.

  25. John I sure like this idea. I can see huge volumes of algae around the world but fortunately the shrimps will come to the rescue and we in turn will be faced with a shrimp population explosion. Now this could be serious but I would like to volunteer for the task force to be raised to eat all those shrimp.

    No, no accolades please it will be a labor of love (love them shrimp)

    Sure beats the h*** out of sequestrating CO2 underground!

    My vote for John as our next president.

  26. Dear Simon,

    Your posts are consistently gloomy, and in my view rightly so. The financial crisis, which seemed as it though was going to change everything, has in the end turned out to be one of those proverbial turning points at which history failed to turn. Most of the readers of this board are, I expect, now looking forward to the next crash, the biggest one of all.

    However, I wonder whether you could tell us if you see any “green shoots,” so to speak, in the political system? We all have a sense of what the big guns are thinking and (not) doing. Obama has turned out to be a shocking disappointment, seemingly in hock to the very forces he so eloquently denounced in his campaign. Barney Frank’s actions so far seem to be as timid as his tongue is sharp. Geithner — well, nothing need be said about the young lad who carries the water for his Wall-Street paymasters. Bernanke — you said it all above.

    So are there any heroes anywhere? Elizabeth Warren? She might be the head of the new Consumer Finance Protection, if it ever actually happens, but will she be able to do anything meaningful or will it all just be about tinkering at the edges?

    Is there anyone else we could look to or rally behind that you can think of? Or are we essentially limited to posting cranky replies on your blog and stocking up on canned goods for our financial fallout shelters?

  27. Francois said, “Most of the readers of this board are, I expect, now looking forward to the next crash, the biggest one of all.”

    If the next is bigger than this one then THAT will change everything.

    Personally, I don’t think this crisis is over, not even close to over, just a lull in the storm.

  28. ‘Personally, I don’t think this crisis is over, not even close to over, just a lull in the storm.’

    I agree with Mr Handover. [if that is your real name, it’s a good one]

    The Crash didn’t change the world by 1930 either. Give this three more years, and then see if nothing has changed.

  29. I’ve seen that, but she did not really address how to fix the problem.

    I hope she will in future.

  30. okay, do you really want to get me going about ben bernanke? he’s the fall guy for the coming second wave of this recession/depression. nothing he has done has stabilized the american economy, inflation is very soon to be here…

Comments are closed.