Should we have re-elected Jimmy Carter in 1980 for his stewardship of the US economy? Of course not. Should Ben Bernanke be reappointed as Chairman of the Federal Reserve for his stewardship of the banking and credit systems? Of course not.
Certainly, the Fed under Mr. Bernanke is not solely responsible for the environment that produced the biggest credit bubble and credit deflation of our lifetimes, but Jimmy Carter wasn’t solely responsible for the late-1980s inflationary spiral. Mr. Carter was not re-elected, and similarly Mr. Bernanke should not be reappointed. Simply put, how can Washington even consider keeping Mr. Bernanke as Fed Chairman when the US banking system effectively failed on his watch?
I have the highest respect for Mr. Bernanke as an academic and economic historian. Nonetheless, there are several reasons, in my opinion, why someone else needs to be the Fed Chairman.
Need for Volker-like Leadership
If one thing positive can be said about Carter’s economic policies, it is that he appointed Paul Volker as Chairman of the Federal Reserve in 1979. The US economy was in the midst of a vicious inflation spiral, but Mr. Volker initiated dramatic changes to monetary policy. Those policies were extremely painful in the short-term, but they stymied inflation and significantly strengthened the US economy’s long-term growth path.
Mr. Bernanke did nothing so dramatic during the obviously enormous global credit bubble. Rather, his policies both before and after the banking and credit crises have attempted to maintain financial market status quo. Despite the crying need for changes to monetary policy at least as monumental as those of Mr. Volker, Mr. Bernanke did nothing to alter the US banking system’s disastrous course.
Mr. Bernanke’s comments regarding his inability to proactively control financial bubbles, and the ease with which the Fed could manage a bubble’s deflation, were astonishing for their naïveté. The fact that the credit bubble’s deflation caused the worst recession of the post-war period seems to demonstrate that Mr. Bernanke has failed even according to his previously expressed expectations.
Wall Street has supported both Mr. Greenspan and Mr. Bernanke. Much like a raw material producer thrives on real asset inflation, Wall Street thrives on financial asset inflation’s cheaper and more abundant credit. Mr. Greenspan and Mr. Bernanke made sure that the Street was not disappointed regardless of the longer-term detrimental effect on the US economy.
The next Fed Chairman should be more concerned with the stability of the financial sector, rather than with the growth of the financial sector. The next Fed Chairman must be ready, willing, and able to take swift and significant action to protect the security of the US financial system regardless of whether Wall Street deems it appropriate or not. Mr. Bernanke has demonstrated no such aptitude.
A New Paradigm of Monetary Policy
The next Fed Chairman must appreciate that a new paradigm of monetary policy is slowly emerging. Central bankers have longed feared inflation (real asset appreciation), and have made fighting inflation the cornerstone of global monetary policies. The last 10 years’ history shows that this may be an antiquated approach.
The future of monetary policy, in my opinion, will focus on the delicate balance between real and financial asset inflation. The US economy does not function well when there is excessive real asset inflation. The 1970s have proven that. However, the US economy also does not function well when there is excessive financial asset inflation. The last decade has proven that. Assets are grossly misallocated when there are extremes in either real or financial asset inflation, and the financial system and the overall economy suffer as a result.
Yet most central bankers, like Mr. Bernanke, do not yet appreciate this delicate balance. They continue to operate under the assumption that real asset inflation is bad and financial asset inflation is good.
In this respect, Mr. Bernanke’s term as Fed Chairman seems to mimic those of Arthur Burns and William Miller during the 1970s.
Burns and Miller promoted policies that fuelled real asset inflation because it was too economically painful (or politically painful?) to do otherwise. Mr. Bernanke has followed the same path with respect to financial asset inflation. His policies, and those of his predecessor, have fuelled excessive financial asset inflation (or bubbles) because it might be too painful to do otherwise. The economy has suffered as a result.
The next central banker must understand the important similarities between the 1970s’ tandem of Burns and Miller and this decade’s pairing of Alan Greenspan and Ben Bernanke. The next Fed Chairman must lead a new paradigm of monetary policy to ensure that neither real nor financial asset inflation becomes extreme.
The Next Fed Chairman
The next Fed Chairman should probably come from one of the Federal Reserve’s district banks. The person should not primarily focus on Wall Street, but rather should fully understand how the optimal cost of capital in the financial markets drives efficient real investment and maintains a stable banking system. The next Fed Chairman should have a thorough understanding of small businesses lending (imagine if TARP money had gone to the Small Business Administration instead of to bank trading desks?) and how the future of the US economy depends on efficient real investment and not on financial engineering.
That person undoubtedly exists somewhere within the Federal Reserve Board but, unfortunately, it is notMr. Bernanke.
Richard Bernstein is CEO of Richard Bernstein Capital Management LLC. He was previously Merrill Lynch’s Chief Investment Strategist and Head of the Investment Strategy Group. He has written two books on investing: Navigate The Noise: Investing In The New Age Of Media And Hype and Style Investing: Unique Insight Into Equity Management.
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