They're Selling, Mortimer!

On October 24, 2005, the day President Bush nominated Ben Bernanke to replace Alan Greenspan, I posted:

Bernanke, of course, it well aware of how his "printing press" comments affected his reputation. So when he takes over for Greenspan, his initial priority will be to establish credibility on inflation, particularly with the bond market. That means higher interest rates. Similarly, when Greenspan became Fed head in 1987, his immediate goal was to establish credibility in the wake of Paul Volcker, a renowned inflation fighter and the most respected Fed chief in history. Greenspan became Fed chairman on August 11, 1987. The price of gold had risen that year from $400 to $465 on Friday, October 16, 1987. On October 19---just two months after Greenspan's first day on the job---the stock market crashed, with the Dow losing 22% on the day now known as Black Monday.

Prediction (not advice): Ben Bernanke will be easily confirmed. And sometime between now and Bernanke's three-month mark as Fed chairman, the stock market will crash. If I'm wrong, fantastic. We'll see.

The crash call was woefully wrong (though possibly a bit premature, depending on what happens this summer). However, a few points are worth noting. First, I was correct about Bernanke's desire to establish street cred as an inflation fighter. While our stock market certainly hasn't "crashed," we're in the midst of a correction that's knocked the major indices to their lowest levels in many months; the Nasdaq is down 12% from its April high. Moreover, some major foreign markets have experienced serious corrections or bonafide crashes; Japan, Hong Kong, India, Brazil and others have lost 10-25% during the past few weeks (and as I type this late Monday night, I see Japan and India are down 4% tonight alone). All this has occurred in part because of the "new guy at the Fed" dynamic that I wrote about last October.

It's important to note that in terms of credibility, Bernanke's been his own worst enemy. Here's a great post at Barry Ritholtz's site that chronicles Bernanke's public flip-flops on interest rates. Part of what's going on here is nanny state-speak. Up until a few weeks ago (it's changed a bit recently) on days the stock market was weak, a Fed official would comment publicly about "the possibility of going too far in raising rates" or how inflation was "well-contained." On days gold was strong and/or the dollar was weak, a Fed official would comment about how "vigilance is needed on inflation." This micromanagement of the financial markets has caused serious credibility problems; in the many years I've been a Fed observer, I cannot remember such a constant barrage of public comments by Fed officials. Bernanke and crew are inverse Teddy Roosevelts; they speak loudly and carry twigs.

One other important point. Some market observers have started making the case that Bernanke "inherited this mess" from Greenspan and is simply "doing the best he can in a difficult situation." Can we dispense with that nonsense right now? Bernanke is not some poor Chauncey Gardiner rube plucked from obscurity. Prior to his current position, he was Chairman of the President's Council of Economic Advisers, and before that a member of the Board of Governors of the Federal Reserve. He's played an integral role in the development and application of both fiscal and monetary policy for years. Particularly under the Bush administration, you don't get to be head of the Federal Reserve unless you're a proven member of the team.

Ultimately, much of this may be academic. As I've posted before, essentially we've ceded control of our own monetary policy to foreign central bankers. They've grown tired of underwriting preemptive wars and irresponsible fiscal policy, and are demanding higher rates of return on our debt. Think about that the next time your mortgage or credit card payments increase, your house falls in value, or the terms become too dear on that small-business loan you wanted. It's all about consequences. Our debt will be sold, whatever it takes---and it's taking increasingly higher interest rates to entice foreign buyers. Combine that immutable reality with a new Fed chief who checks his chest hair in the mirror each morning, and you've got a recipe for interesting times ahead.