The Measure of Ben Bernanke

Repeatedly, I have been asked: Will Ben Bernanke fight inflation as effectively as Alan Greenspan?

The Fed has responsibility for both sustaining growth and containing inflation. It is easy to do one but not both. The Bundesbank and European Central Bank have demonstrated achieving modest inflation and 10 percent unemployment is easy, whereas Alan Greenspan has shown containing inflation and keeping unemployment at five percent or less is doable.

Unfortunately, Mr. Bernanke will have fewer tools than did Mr. Greenspan or his predecessor, Paul Volker. Both had to manage monetary policy around less than prudent fiscal policies: Democratic presidents bent on punishing enterprise with high taxes and Republican presidents inclined to spend the Treasury broke. Now, President Bush and Treasury Secretary Snow have abdicated exchange rate and interest rate policies to Beijing.

Since 1995, China has pegged the yuan to the dollar, and bought large sums of U.S. securities to sustain an undervalued currency as its trade surplus swells. These Chinese purchases push down U.S. long-term interest rates. In turn, these have given the U.S. economy inexpensive mortgages and a housing bubble, a consumer driven expansion, and a $700 billion dollar trade deficit, which cannot be wholly explained by a federal budget deficit only half as large.

By soft peddling Chinese currency manipulation, Treasury Secretary John Snow has deprived the Fed of influence over long-term interest rates. Since June 2004, the Fed has raised the federal funds rate from 1 percent to 4.25 percent, while the rate on 20 year Treasury bonds has fallen 0.62 percentage points.

Now, the economy is about to go the other way. The housing market is cooling and consumers cannot borrow to spend much more. Slowing retail sales and a growing trade deficit are taxing growth, just as petroleum prices are taking off again.

The Fed cannot do much about oil prices — these days, U.S. growth only marginally affects international commodity markets — and the Fed cannot do much to spur growth by lowering the federal funds rate. Lower short-term rates do little to help consumers when home prices are stagnant or falling, as is likely in the months ahead.

The potential for economic growth is apparent: worker productivity is advancing robustly, and entrepreneurs are cranking out amazing new products. However, to translate those accomplishments into strong GDP growth and higher wages, U.S. businesses and exports cannot labor under a chronically overvalued dollar, and Mr. Bernanke must convince Secretary Snow, also a PhD economist, to get serious about Chinese currency manipulation.

Mr. Bernanke's macroeconomic textbook reveals he understands that exchange rates can be a powerful lever to ignite growth. Does Bernanke have the political skill to move Snow to action?

For Mr. Bernanke, the first major test will be in the same place as it was for Mr. Greenspan — a meltdown in asset markets. Shortly after assuming office, Mr. Greenspan managed the economy through the 1987 stock market crash. For Mr. Bernanke, his crisis will likely be in the foreign exchange or real estate markets, stemming from all those dollars we printed and sent abroad to pay for our trade deficit.

Navigating such storms, Mr. Greenspan had the advantage of many years of private sector experience, which can be both humbling and enlightening for university economists. Often, solutions we would never embrace as a long-term policy, like flooding banks with liquidity, are essential tactics for surviving a crisis. Those kinds of challenges are never adequately appreciated in the cosseted confines of college classrooms. How quickly can Bernanke overcome his academic legacy?

Mr. Bernanke's real challenges lie in accepting that markets are messy places and blackboard remedies won't do, and in finding the personal courage and political skills to act on what he learns.

Treasury Secretary Snow Buys Brooklyn Bridge From Chinese! (Again!)

"And I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale."
-- Thomas Jefferson to John Taylor, May 28, 1816

"I am one of those who do not believe that a national debt is a national blessing, but rather a curse to a republic; inasmuch as it is calculated to raise around the administration a moneyed aristocracy dangerous to the liberties of the country."
-- President Andrew Jackson - (1824)

"Of all forms of tyranny the least attractive and the most vulgar is the tyranny of mere wealth, the tyranny of plutocracy."

~ Theodore Roosevelt

Consumption drives the economy. Not the Fed.

Those who have been talked into believing that the Fed is the end all and be all of the economy don't really understand what effect consumption has.

ONLY the Fed can cause inflation, for an individual or corporation who causes inflation would be guilty of Counterfeitting. All Money "Federal Reserve Notes" since 1971 when we were taken off the Gold Standard completely were and are created out DEBT.. Thats right for there to be 1 dollar in circulation, someone had to borrow it into circulation. America needs to wake up and realize the the Fox is Watching the Hen House. ONLY THE FEDERAL RESERVE SYSTEM CAN CAUSE INFLATION!!! not keep it in check

ONLY THE FEDERAL RESERVE SYSTEM CAN CAUSE INFLATION!!! not keep it in check..

Yet, when you look at this chart (post 106) you'll find that inflation has been much less volatile since leaving the gold standard than it was prior. Go figure.

Consumption drives the economy. Not the Fed.

Investment and innovation drive the economy. If it was consumption, a talent everyone has, then every economy in the world would be doing well.

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.