September 17, 2018
We Still Haven’t Learned the Right Lessons from the 2008 Crash
Financial media-administered history lessons — whether by commentaries or interviews — on the Great Crash that occurred 10 years ago are frightening. The would-be history teachers are in total denial (or ignorance) of the key fact that 2008 was a monetary-made disaster. This climate of denial continues to foster ever greater danger in the future not to mention a heavy cumulative burden in the decade since — as measured by prosperity lost.
In effect, the Central Bankers Club and their backers among the political elites have been totally successful, it seems, in expunging monetary forces as the key driver — or even as a major factor — in the journey to the 2008 Crash. This started with President George W. Bush nominating Ben Bernanke as a Fed Governor (effective August 2002) in the clear expectation that this Princeton Professor would prove effective in implementing the monetary inflation which he preached. True, Alan Greenspan was still the chief, but by then on shaky footing, given the known hostility of the Bush-Baker “clan” which resented his earlier close cooperation with the Clinton Administration. And Before that, Greenspan was perceived to have some responsibility for the 1991-2 economic downturn which spelled defeat for the older Bush. The implicit term extension deal for Greenspan in 2003 (by two years) was that he would “listen” to the new Governor from Princeton.
George W. Bush’s expectations were met when the Greenspan/Bernanke Fed in early 2003 decided on the novel policy of “breathing in inflation” from what it perceived as too low a level. The Princeton Professor was a zealot of the 2-percent inflation standard and had no truck with concerns that the rhythm of prices was now downwards for some time due to the nature of technological change and globalization. The result; monetary inflation in the asset markets (credit, real estate, in particular) developed in a virulent form (including its well-known aspect of rampant financial engineering).
The European and Japanese central banks, confronted with a weak dollar, initiated their own policies of monetary inflation. There was the notorious adoption of a 2-percent floor (the same height as the ceiling) to inflation by the ECB. This was announced with much fanfare by Professor Otmar Issing (the ex-Bundesbanker eminence grise) in Spring 2003. Meanwhile, the BoJ was running the first modern experiment in quantitative easing.
Then in the two years following early autumn 2004, the Federal Reserve (Bernanke became Chair in February 2006) relentlessly raised the Fed funds rate in mini equal steps by 425bp (from 1% to 5.25%). No question that was a sharp tightening of monetary policy, and unsurprisingly in 2006, there was much commentary about an evolving housing downturn and economic slowdown. But the Fed did not budge given that CPI inflation in the middle months of 2006 briefly spurted to just above 4% year-on-year before receding suddenly and sharply back towards target.
We learn from Milton Friedman that monetary policy operates with a long and variable lag. And by Spring 2007 the signs of credit market pull-back were multiplying; then a first crisis of illiquidity erupted in Europe and in the US during Summer 2007, evident in both the banking system and the wider shadow banking system. Even then the Bernanke Fed would hardly ease policy, relying instead on a multiplication of special liquidity measures to keep the banking system afloat.
The NBER now dates the US recession as starting in the fourth quarter of 2007. But at end of that year, the Fed funds rate was down barely 100bp from its earlier peak. The Fed continued with small and steady cuts of official rates through the first few months of 2008. This most likely meant that overall monetary conditions tightened, given the contemporaneous business cycle slowdown and credit market pull-back. Indeed, during late Spring and early Summer (2008) the Fed signaled that rates could increase in response to the “inflationary effect” of the oil market bubble at that time. And even in the autumn of 2008 in the midst of financial panic, when the Bernanke Fed at last allowed short-term rates to collapse, it prevented them reaching zero by starting to pay interest on reserves.
In sum there were two distinct elements in the monetary policy errors of 2003-8. First, there was intense monetary inflation — and then a powerful reining back of this — which was so rigid as to totally become out of line with the development of the business cycle. These failures of monetary policy remained hidden it seems from mainstream critiques and the political process. There were some exceptions, including Senator Bunning’s famous attack while when voting against Bernanke’s re-nomination as Fed Chair by President in 2009: “you are the definition of moral hazard.”
Instead Chief Bernanke, for many, became the hero who had “courageously” intervened to save the system (indeed his autobiographical title is “The Courage to Act”). And he obtained a license from the political process for even more radical monetary experimentation than in the previous cycle. Amazingly, 10 years on from the Great Crash the ECB and Bank of Japan are still stuck in emergency mode (with negative interest rates and QE) while the Federal Reserve has barely shrunk its massive monetary base (which has become un-pivoted in any case from the monetary system by payment of interest at a market rate) and its official interest rate is still negative in real terms.
This unprecedented length without even intermittent pause or reversal of monetary inflation (camouflaged still in goods and services market by globalization and technological change) most likely will have severe and fateful consequences; the extent of these will be a direct consequence of society’s failure, and in particular the political system’s failure, to confront the monetary mistakes running up to the Great Crash. We have now the ironic situation where the monetary architects of the crash including the Bernanke loyalists and hangers on appointed by President Trump to the Fed Board are enjoying an Indian summer of non-repentance and adulation. One example: CNBC’s airing on September 12 of a 3-way smiling and laughing discussion at Brookings between Messrs. Bernanke, Geithner and Paulson, chaired by an un-named toady interlocutor.
Behind this lies the continuing roar of the bull market in US equities and of course the “boom” in the US economy which is in fact a substantial growth cycle upturn since mid-2016 empowered by the “Yellen Put” and its international accompaniment at that time. The lesson from all this: failure to learn will likely include an even bigger potential disaster next time. The full extent and nature of that disaster would emerge with long and variable lags after key dates in the monetary inflation process. Albeit, the perspicacious can already note its translation into the curses of monopoly capitalism and real wage stagnation in the present business cycle to date.