A Limp Recovery Questions Ben's High Self Regard

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On December 16, 2009, Time Magazine announced that Ben Bernanke was the Person of the Year for 2009. The subtext under the headline noted that, "The story of the year was a weak economy that could have been much, much weaker." The portrayal of the Fed Chairman in the accompanying piece was one of a regular guy who eschews limelight and power politics. Time even went so far as to call the Chairman a "nerd".

Immediately after that playful compliment, it was qualified by the statement that he, "just happens to be the most powerful nerd on the planet."

More than three years after those accolades, Mr. Bernanke continues on as the Chairman of the Federal Reserve System and continues to labor under much the same task. Conventional wisdom, and the Time honorific was just the first of many to enshrine the Fed's "heroism" toward that end, has said that the Great Recession ended in the middle of that year. It has since been posited, and seemingly accepted (by most), that the financial panic and crisis have passed into history as well.

It must seem somewhat strange, then, that the most powerful nerd currently living, perhaps that has ever lived, is continually fending off rather stark and pointed critiques of his monetary stewardship some four years after the worst has passed. Of course some of it will be chalked up to pure politics since only one side of the conventionally constructed political divide seems at all curious as to what the Federal Reserve is contemplating. If it was purely politics, however, it would have ended long ago as Republicans have no will to carry political battles on their own without some determined public interest ( Benghazi comes to mind).

There is something far more basic behind the once proclaimed genius nerd facing direct and hostile questioning, under oath and on the official record. That fact, esoteric and intangible as it may be, speaks volumes about the track record achieved under the current monetary regime. Monetary policy, some forty-three months after the official end of the last recession, should be almost completely uncontroversial at this stage of a recovery.

In reality, nearly four years after the end of the contraction and economic dislocation, recovery itself should be a historical concept. We should be talking about the exact trajectory of the current "boom" and looking for signs of "overheating" and perhaps looking out for the next potential dislocation. Congress should not be asking why we remain millions of jobs short of the previous "cycle" peak (reached nearly six years ago).

Chairman Bernanke throughout the perpetual recovery phase was never accused of sitting idly, careful and measured in his policies. Since he made his name picking apart a past Federal Reserve regime's idleness it would have been improbable to expect the same. Instead, the focus of questions and inquiry into the Federal Reserve has been directed toward the aggressive and seemingly unending efforts to follow up on those 2009 tributes.

Much has been said in the last few days about the Chairman's exchange (described by many as "testy") with Senator Bob Corker. His reply to the question and suggestion of being the biggest monetary "dove" in the postwar era and a potential causative effect on the economic system certainly drew attention. Much as the Chairman might be a reserved nerd, his response betrayed that characterization, making it newsworthy. And that was to be expected since the implicit framing of Senator Corker's inquiry was to suggest an answer as to why the country is still wondering and questioning about recovery.

It was curious that Bernanke went to his record on inflation as his response. It dismissed the primary line of inquiry completely (connecting dovishness with the lack of recovery), speaking only to the festering fears of such expansionary policy. The Chairman well knows that the primary, explicit criticism of his extreme measures is the expectation of future inflation. By countering Senator Corker directly with his own record on inflation, past tense, he sought to "paint the tape" on what to expect in the near future.

To his main point, the Chairman was absolutely correct. His record on inflation has been, by the numbers, the best in the postwar period. Across his Chairmanship, by and large inflation has been at 2%. By the narrow interpretation of success that he set forth, he has to be judged as worthy of Time's 2009 exaltations.

In the years since he has been at the helm of FOMC policy his inflation record "benefits" from a period of extreme disinflation. Under his watch, Bernanke has seen periods of excess price movements in either direction. We might question as to whether the economy, or society as Senator Corker addressed it, actually benefits from such volatility, but that does not matter in the simple assessment of inflation during Bernanke's tenure.

In so many ways, the Chairman's framing of successful policy mirrors the growth of the Federal Reserve as an agency of monetary and economic management. Alan Greenspan never endured such "testy" questions, and certainly not from Republicans. But it was under his regime that the Federal Reserve stopped being a monetary bean counter and began elevating monetary policy to soft central planning. Because consumer inflation had been falling since 1980, the Fed was assumed to be successful no matter what policies it exerted into the economic realm. It was largely judged by that one measurement.

As the 1980's progressed into the Great "Moderation," the Fed became emboldened to unleash rational expectations theory and interest rate targeting as the keys to eliminating the business cycle. And as long as consumer inflation was low, judged by the narrowing definitions of the CPI, politicians of both parties (it was the Democrats that were supposed to be hostile then) abdicated their responsibilities toward sound monetary management.

If all we use as a measure of success is the CPI or the PCE deflator (pick your academic inflation measure), there is no arguing that the Federal Reserve since Volcker has been an unparalleled success. Even in more recent years, under the pressure of extreme dovishness trying to force a recovery to appear, these narrowly defined inflation measures have been tame. For all the arguments about rising commodity prices, gasoline prices, for example, first crossed the $4 per gallon threshold in 2008.

For an economist, the fact that gas prices have been up and down throughout the whole of the Great Recession and Great Waiting amounts to zero inflation. It's a wash because economics lives in the second derivative - it matters not what nominal level prices achieve, only how fast or slow it changes. Currently, the average price per gallon is about $3.73 (depending on who is measuring). According to the same measure, in late February 2012, gasoline prices averaged about $3.68 per gallon. Inflation in gasoline over that time amounted to 1.4%, even better than Bernanke's full-term average. If gasoline prices were conforming to a high inflation environment, we would already be at $5 or $6 per gallon by now.

On that narrow score alone, it is hard to argue with the academic logic. But there is still the missing piece of forty-three months of missing recovery. That is enough of a qualification to the record of the current Fed as to warrant moving slightly beyond narrowly construed inflation measures (with or without the "beneficial" assist of economic collapse). Just as the missing recovery now warrants closer scrutiny beyond simple academic inflation, asset bubbles during the Great "Moderation" should have raised the standards for past Fed success beyond that same simple consumer inflation record.

Going back to the original question Bernanke was asked, Senator Corker was actually attempting to make the case that QE's and Twists and ZIRP are "degrading" society. That is a broad sentiment that challenges the narrow comparison of the price of goods in dollars. Degrading society sounds more like a deeper dysfunction where dollars might not be the right comparison standard at all.

For economists, nominal levels make little difference. But that is only insofar as prices are compared to currency. Inflation in the strictest academic sense is not even commodity price second derivatives. Inflation, commonly understood by conventional economics, is the combined impact of rising income with general prices. Under this accepted construction, the second derivatives of both wages and prices are moving in the same direction largely at the same time, with one pushing the other in a feedback loop.

This conventional definition of inflation is clearly absent currently. In fact, depending again on who is measuring, median family income has fallen between 4% - 8% during the combined Great Recession and Great Waiting. On a relative basis compared to family income, gasoline prices derive a new context that actually appears and feels much like inflation. And in that broader context, nominal levels make a hell of big difference. A family that is unable to increase its earned income level has a hard time handling $4 gasoline at any and all times. It matters little if that nominal $4 level stays there with no growth in the second derivative inflation measures - it's all bad.

In that sense, current dovishness has not only not succeeded (double negative), but has failed rather vividly. The intentions of QE on top of ZIRP are to push inflation expectations upward, leading to the threat of negative real interest rates. Again, inflation expectations in this context are the wage/price dynamic. That means that QE on ZIRP can only be judged as successful if and when it actually creates wage inflation leading to price increases. In that sense, conversely to Bernanke's own defense, the absence of a higher CPI reading belies his own intentions. The Chairman expressly wants more inflation.

QE was rolled out as a way to get the economy moving forward through rational expectations theory. By playing on inflation fears of debasement the Fed actually expected market participants to react as if inflation was imminent. That meant creating a lot of economic activity based on those artificially created expectations. It was simply assumed that hiring and growing incomes would be part of that process, and it would lead directly and immediately to a recovery (exiting the extreme dovishness would then be the topic of testiness).

That actually happened except it was very narrowly constrained. There was absolutely one segment of the economy that saw rising income and activity - corporate businesses. Corporate profits rose dramatically throughout the QE periods, only recently tailing off. Yet those profits never turned into full employment, which was in total opposition to historical patterns and expectations based on them.

In reality, as opposed to academic exercises, inflation is not a uniform principle or symptom. Inflation and price changes impact different segments and spaces of the economic system in far different ways. I have no doubt Chairman Bernanke is at least now aware of that (admitting as much in answers to other pointed questions, such as the plight of fixed income savers). But he keeps returning to the idea that the aggregate effect of monetary dovishness is a stronger economy that benefits all of us in the end.

The last part of that construction is undoubtedly true in that a strong economy not only benefits everyone, it would end the Congressional inquisitions. So somewhere between monetary expansion and real, organic growth, something is amiss. Inflation expectations are supposed to create inflationary conditions that lead to rising incomes, but that only happened in the narrow segment of large corporate business (that benefited from a weaker dollar). The Fed Chairman is supposed to be exhibiting and representing higher inflation as a means of measuring success, not tame numbers.

Since corporate business is (at least was) the sole bright spot, we might want to examine the further relationship of extreme monetarism and corporate incomes. It should not be at all surprising that the combination of QE on ZIRP and inflation expectations leads to corporate desires to focus on "monetary value" for shareholders rather than "productive value."  The appearance of asset inflation has a definitive impact on corporate decisions about internal resources.

Asset inflation does not appear in the conventional economics textbook, but it takes all forms. Ostensibly this is a welcome form of inflation (though it will not be termed as such), expressly desired by monetary officials as an additional psychological push on the tendency to consume and create generic activity - the so-called "wealth effect". But not all asset inflation is stock prices; commodity prices can and do experience asset inflation as well. So the intentional act of creating inflation expectations through extreme dovishness has the dual effect of pushing up the nominal levels of commodity prices while at the same time reducing the incentives of corporate businesses to invest productively (among other effects).

That about explains why we are still talking about the recovery that won't seem to appear some forty-three months after it should have. Chairman Bernanke is absolutely correct by-the-numbers, yet Congressmen will continue to harass the Chairman of the Federal Reserve to explain if there are any side effects to massive monetary measures beyond the fact that they still have to ask. The Federal Reserve can only continue on its current path as long as people continue to accept that the definition of success can be so narrowly construed.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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