Showdown at Jackson Hole: Is Bernanke Out of Bullets?

Thursday, 26 Aug 2010 09:00 PM

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The Dow's plunge below 10,000 Thursday means all eyes will be on Fed Chairman Ben Bernanke's much-anticipated address Friday to the world's central bankers at Jackson Hole, Wyo.

Analysts say Bernanke may signal the Federal Reserve's next move to counter growing deflationary pressure and joblessness in the U.S. economy.

In his last public-speaking engagement in July, Bernanke assured the U.S. Senate that the Fed is "not out of bullets" to direct the economy, despite interest rates already at near record low. Given the economy's decline since July, Bernanke may well be expected to prove that assertion at Jackson Hole.

Reassuring Wall Street is critical considering that many economists now predict unemployment will head back over 10 percent, possibly just in time for November midterms -- a bone-chilling prospect for incumbents hoping to win re-election.

U.S. home sales last month dropped to their lowest level since record keeping began in 1963, plummeting 32.4 percent compared to the same month one year ago.

But what's likely on Bernanke's mind as he prepares for his critical speech is that worse news probably lies just ahead: The Bureau of Economic Analysis is expected to announce Friday that second-quarter U.S. economic growth was actually just a fraction of the level originally reported: 1.4 rather than 2.4 percent. That news could rattle already nervous markets.

"We had hoped by this point we would see much better performance from the economy, and now we're trying to get a sense of how weak things are without the stimulus," Paul Nolte, managing director at Dearborn Partners, told MoneyWatch.com after the market closed below 10,000 on Thursday.
Nolte's reaction was tepid compared to the projections of David Rosenberg, chief economist for the independent investment firm Gluskin Sheff.

In remarks that could turn up the heat on policy makers even further, Rosenberg told Fox host Neil Cavuto Thursday afternoon that the U.S. is in a depression. This is not the typical post-WWII downturn that could be cured in four or five quarters by fiscal measures designed to encourage businesses to replenish their inventories, he said. Rosenberg said this downturn is a "debt-deleveraging cycle."

"As we're finding out whether it's cash for clunkers, or cash for appliances, or housing subsidies, there's no quick fix to a debt deleveraging cycle," Rosenberg told Cavuto. "We got into this mess because we went through a multi-year credit cycle, a credit expansion that went absolutely -- we let it happen, at all levels of society, including the government -- that we went through a parabolic credit cycle of 2001 and 2007, and we're paying the piper right now because a lot of this debt is bad and has to be extinguished."
He predicted it will take five to seven years before the U.S. economy has another sustainable bull market.

Of course, Rosenberg hardly represents the views of most economists, who say the economy will probably avoid a double-dip recession. But the growing restlessness of Keynesian and non-Keynesian economists alike suggests that Bernanke, who won Time magazine's "Person of the Year" honor last year, must demonstrate Friday that he does indeed have additional ammunition to bolster economic activity.

Here's an informal survey of what various experts and policy makers are suggesting Bernanke should do:

Paul McCulley, managing director of Pacific Investment Management Co. – Speaking on Bloomberg Radio, McCulley said the No. 1 thing Bernanke has to do is clarify the Fed's economic views. It should begin, he says, with the Fed revealing what its downward revision is of its economic projections for 2011, which have yet to account for the recent spate of dim economic reports. Secondly, he says, the Fed needs to state its contingency plans for so-called "quantitative easing," the Fed practice of purchasing large quantities of Treasury bonds and mortgage-backed securities in order to expand the money supply and drive down long-term interest rates. (Skeptics abound that further asset purchases will spur economic activity.)

Alan S. Blinder, Princeton economist and former Federal Reserve Vice Chairman – In a Wall Street Journal editorial Thursday, Blinder mentions the quantitative easing approach touted by others. He also says Bernanke could charge banks 25 basis points as a "negative interest rate" on their $1 trillion of excess reserves. Changing banks for storing money would spur them to do something else with it -- such as making loans to businesses and consumers.

He also suggests announcing that bank examiners allow banks to incur some losses due to bad loans as a normal part of doing business, so they're not afraid to show a new default on their books.

Michael Casey, Dow Jones Newswires columnist – Casey says Bernanke should "declare war on deflation." In a Wall Street Journal column Casey argues Bernanke should state that its primary goal is to heat up the economy via modest, controlled inflation. He adds it should clarify what its promise to keep interest rates low for an "extend period" actually means. "It could state that this means rates won't be increased until healthy inflation returns, even if the economy is growing rapidly," he writes.

William Poole, former president of the Federal Research Bank of St. Louis – Some economists believe what Bernanke really needs to do is demonstrate a calm sense of leadership, use his powers of persuasion, explain the Feds latest policies, and express confidence that the economy is on the path to recovery. Says Poole: “The challenge is for Bernanke to communicate to the world at large -- to financial markets and the public -- that monetary policy is currently contributing to the economic expansion, and we need to be patient."

Other observers say Bernanke may not have the latitude to clarify Fed policy that he might like. There is a reported split among members of the central bank over whether quantitative easing would just trigger more concerns over a possible economic downturn.

Goldman Sachs analysts issued a statement earlier this week suggesting that Bernanke may have no option but to remain cryptic on certain key points, knowing that members of the Federal Open Market Committee may be at odds over what action to take.

"Under these circumstances, it would be premature for Chairman Bernanke to provide a set of guideposts for future policy moves, as helpful as that would be for the markets and as much as we believe that additional easing will ultimately be needed," the analysts stated. "Instead, we expect him to concentrate on how the economy and the Fed have come to where they are now, with at best just a general sense of economic risks in the months ahead."







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