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AFTER BEING VOTED Time magazine's Person of the Year, Ben Bernanke probably figures his work for 2009 is done.
The Federal Open Market Committee announced it maintained its policy stance, consisting of pegging the rate on overnight interbank loans at 0%-0.25%, and reiterated the economic conditions "are likely to warrant exceptionally low levels of the federal-funds rate for an extended period."
More newsworthy was what didn't happen: no increase in the discount rate or announcement of plans for an exit strategy, as had been suggested by the Financial Times Tuesday.
The FOMC's statement did take note of a couple of improvements in the economic and financial backdrop, notably that "the deterioration in the labor market is abating," in other words getting worse more slowly. (At least that's if you take the highly suspect November employment numbers at face value.)
In addition, the FOMC also observed, "Financial market conditions have become more supportive of economic growth," which states the obvious improvement in the capital markets. Credit-quality spreads have shrunk drastically this year while even junk borrowers are able to raise money using dubious, speculative structures.
But credit remains constrained for medium- and smaller-sized businesses by "fat cat" bankers, as President Obama called them. As usual, the message from Washington is mixed. Banks face further loan losses, particularly in commercial real estate, and regulators want them to beef up balance sheets to absorb them. That necessarily means restricting asset growth -- in other words, lending.
Bernanke was dubbed Person of the Year by Time for recognizing the breakdown of the credit mechanism was the key factor that caused the Great Depression (in part because the Federal Reserve then was "fettered" by the gold standard, to use the phrase of Barry Eichengreen of the University of California, Berkeley). By contrast, the Fed this time took decisive steps to prevent a repeat of that debacle.
In Wednesday's statement from the FOMC, the panel said it expects to shut down most of the special liquidity facilities on Feb. 1, and others by June 30. The Fed previously said it would wind them down. In any case, the amounts borrowed through them have dwindled as money-market conditions have improved.
What the Fed is not doing is to mechanically drain the reserves it has provided to shore up the banking system. One observer points to an "astounding" 255% increase in bank reserves, a 295% jump in excess reserves and a 77% increase in the monetary base (reserves plus currency) over the past year. The narrowly defined money supply, M1, has jumped by 13.5%. That, it was asserted by this analyst, is well in excess of the 6% money growth required by the economy.
Unlike this observer, who has absorbed the Cliff Notes version of monetarist theory, Bernanke has learned monetary history from Milton Friedman and expanded upon his key insights on how the financial breakdown of the 1930s brought about the Great Depression. The jump in the money stock has been met with a steep drop in its velocity; translation, the money is being sat on, not spent, and has no inflationary potential.
Absent credit growth, a modern economy is stymied. Big corporations with access to the bond market are lapping it up while small businesses dependent upon banks are parched. Bernanke understands this and won't start tightening monetary policy until credit conditions normalize.
To be sure, the praise heaped upon Bernanke by Time should be tempered by the recognition of the Fed's role in letting the credit crisis erupt. Joan McCullough of East Shore Partners acerbically likens the Fed chairman to a house-sitter who falls asleep with a lit cigarette and then gets credit for helping the fire-fighters to put out the conflagration.
That's a bit harsh. While the authorities -- including former Treasury Secretary Hank Paulson and his successor, Tim Geithner, who was the New York Fed president -- were complacent when they claimed the subprime problem was "contained" -- Bernanke did react boldly and innovatively to contain the credit crisis.
Was it the right thing to do? It can only be argued using a contrafactual: what might have happened had the Fed not acted by vastly expanding its lending and its liquidity provision? The aftershocks of the Lehman failure suggest what might have happened.
Still, Time's accolade comes as the Fed and its chief face opposition the likes that haven't been seen in more than a quarter century. Bernanke will be confirmed for a second term but will face an increasingly hostile Congress (and maybe even White House) should the Fed raise rates while unemployment remains in or near double digits.
Given the history of Time covers proclaiming a trend just as it is about to turn, if Ben Bernanke were a stock, being voted Person of the Year could mark his "top tick."
Comments: randall.forsyth@barrons.com
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