Bernanke Blues

Federal Reserve Chairman Ben S. Bernanke said the growing U.S. budget deficit could push borrowing costs higher and curb economic growth. (from Bloomberg News, Mar 1, 2011 11:23 AM).

The FED has had the acclerator on full for some time now.  There’s some evidence of a pickup in the economy (except of course for employment) so keeping the U.S. awash in liquidity has been having its desired impact.  But what happens if the multiplier (remember your economics – I borrow to buy from Bobby, Bobby uses the money I gave him for a down payment on a house or something, and proceeds to mortgage (i.e. borrow) the house and so on)  effect remains unchecked for too long?

One problem that occurs was eloquently put in a comment made on Feb. 24th by Weiping Tong concerning my Lessons Learned from the Economic Crisis posting:

Excessive liquidity in the past has saved the weak segments in the economy from falling apart, however, at the cost of creation of new bubbles. After the Asian financial crisis, internet and technology stocks went into the bubbles. After the recession in 2001, U.S. housing market went wild. After the financial crisis in 2008, gold was the first asset to hit new high.

However the REALLY BIG issue for Bernanke is that nobody knows how much monetary easing is too much.  The shrinkage (makes me think of a Seinfeld episode…giggle) in global liquidity as a result of the financial meltdown is impossible to quantify.  Think of it as a gas tank – the crisis (2008 and 2009) was like a leak in the world’s global gas tank.  Unlike a gas tank though, there’s really no fuel gauge to determine how much liquidity was lost. 
The U.S. and other leading countries have simply been pumping in more gas and hoping for a sign that the tank is back to full again.  To address Weiping’s point – when and if it is full, measures will be taken to stop the flow of gas – and those measures will create the busting of bubbles we dread (a bubble bursting is like another leak opening up in the system).

Confused? The gas tank on my Harley only holds so much gas.  If I drive across deserted terrain long enough……well I run out of gas completely.

 The world economy risked running out of gas during the financial crisis (massive leak), and rather than be stranded in the middle of no-man’s-land Bernanke and his peers have been pouring in the fuel – and borrowing the funds to do it from future generations.  HIS fear is not much different than the average unemployed consumer (hey, that’s me) using credit cards.  Eventually the U.S. economy will run out of its ability to borrow.  This will devastate the U.S. dollar, drive the ‘cost’ of borrowing higher (have to borrow to pay debts) and a financial cyclone is ignited.  When we think of hyperinflation we usually associate it with post-war Germany or Brazil, but from October of 1861 to March of 1864 the commodity price index in the Confederate States of America rose an average rate of 10 percent per month. When the Civil War ended in April 1865 the cost of living in the South was 92 times what it was before the war started. 

Bernanke wants to have a smooth trip, and this requires the government to begin acting responsibly by taking its heavy foot off the accelerator to conserve fuel, at least begin too payoff some debt (deal with the huge U.S. budget deficit).  Keep an eye on the economic gauge and top up only when absolutely necessary.

Invest to Live, Live to ride.

About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He recently authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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