Alan's Finance Blog

Bernanke’s Burn Notice – Why Now? Research Reveals Insight Into Fed Chairman’s Popularity

By Elliott Wave International

Like a spy who gets a burn notice, Federal Reserve Chairman Ben Bernanke has suddenly lost his support.

Bernanke has gone from being Time magazine’s Man of the Year in 2009 to … what? A Fed chairman embroiled in a controversial reconfirmation process before U.S. Congress. Why the sudden turnaround in his fortunes?

Robert Prechter, president of the research firm Elliott Wave International, has written about the history of the Fed and its chairmen several times over the years, and his research shows that their popularity rises and falls with social mood, which is measured by the stock market. Here is a compilation of excerpts from Prechter’s monthly market letter, The Elliott Wave Theorist, from 2005-2009 about the trouble he sees brewing at the Fed.

Can the Fed Stop Deflation? Robert Prechter answers this all-important question in his Free Deflation Survival Guide. The guide gives you a 60-page ebook that will help you understand deflation and its effects on society; you’ll even learn how to survive and prosper in such an environment. Download Your Free 60-Page Deflation eBook Here.

(November 2005) The Coming Change at the Fed | Public figureheads have a way of representing eras. This is certainly true of entertainment icons and politicians. The history of Fed chairmanship implies a similar tendency for changes of the guard to coincide with changes in social mood and therefore stock prices and the economy. [The chart below] depicts our social-mood meter—the DJIA—since the Fed’s creation in 1913, marked with the reigning chairmen according to a list on the Fed’s website.

The first chairman, Hamlin, presided over a straight-up boom. As it ended, Harding took over and presided over an inflationary period that accompanied a bear market, exiting just as a new uptrend was developing. Crissinger took over at the onset of the Roaring Twenties, and Young presided over the boom, the peak and the rebound into 1930. Meyer took over just as confidence was collapsing and left the office in early 1933 at the exact bottom of the Great Depression. The next three chairmen struggled through the choppy years of the 1940s. Then Martin presided over virtually the entire advance from the early 1950s through 1969, exiting just before the recession of 1970. Burns and Miller presided over a bear market and exited as the new uptrend was developing. Volcker, after weathering an inflation crisis, presided over the explosive ’80s. Greenspan has presided over the manic ’90s and the topping process. [Ben Bernanke] will have his own era. Given the eras that have immediately preceded the coming change in leadership, the odds are that this new environment will be a bear market.

(June 2006) Economists are convinced that the Fed can “fight” inflation or deflation by manipulating interest rates. But for the most part, all the Fed does is to follow price trends. When the markets fall and the economy weakens, the price of money falls with them, so interest rates go down. When the markets rise and the economy strengthens, the price of money rises with them, so interest rates go up. The Fed’s rates fell along with markets and the economy from 2001 to 2003. They have risen along with markets and the economy since then. Regardless of the Fed’s promise to keep raising rates, you can bet that the price of money will fall right along with the markets and the economy. Pundits will say that the Fed is “fighting” deflation, but it will simply be lowering its prices in line with the others.

It is highly likely that the next eight years or so will test the nearly universally accepted theory—among bulls and bears alike—that the Fed can control anything at all. The Great Depression made it look like a gang of fools, as will the coming deflationary collapse. We have predicted unequivocally that the new Fed chairman will go down as Hoover did: the butt of all the blame, and if you are reading the newspapers you can see that it’s already started. “When Bernanke Speaks, the Markets Freak” (San Jose Mercury News, June 10, 2006); “Bernanke is being blamed for spooking Wall Street” (USA Today, June 7, 2006); “Bernanke to blame for volatility” (Globe and Mail, Canada, Jun 13, 2006). The new chairman had a brief honeymoon (which we also predicted), but it’s already over.

By the way, I heard his commencement speech at MIT last week, and in it he spoke eloquently of the value of technology and free markets. But he also opined that economists have successfully applied technology to macroeconomics. We believe that the collective unconscious herding impulse cannot be tamed, directed or managed. In our socionomic view, the Fed cannot control the mood behind the markets, but rather, the mood behind the markets controls how people judge the Fed. We’ll ultimately find out who’s right.

Can the Fed Stop Deflation? Robert Prechter answers this all-important question in his Free Deflation Survival Guide. The guide gives you a 60-page ebook that will help you understand deflation and its effects on society; you’ll even learn how to survive and prosper in such an environment. Download Your Free 60-Page Deflation eBook Here.

(December 2009) Bernanke’s greatest achievement was not the measly $1.25t. of debt that he arranged to have the Fed monetize; it was convincing the government to shift the burden of debt default from the speculators and creditors to taxpayers.

(September 2009) Thanks to the Fed Chairman and two Treasury Secretaries, profligate bankers have been cashing checks off the Fed’s and the Treasury’s accounts, and the poor savers and taxpayers who fund these institutions are unaware that their personal bank accounts are being tapped by counterfeiters and thieves.

That lack of awareness may soon change. Declining social mood is fueling the drive to expose the Fed’s secrets. [Ed. note: Bloomberg News has sued the Fed under the Freedom of Information Act; Congressmen Ron Paul, R-Texas, and Barney Frank, D-Mass., are leading a charge to audit the Fed.] Exposing the Fed’s secret deals could lead to scandal and the collapse of major money-center banks. But most important to our monetary outlook, it will serve to curb the Fed’s reflation efforts. As I have written many times, deflation will win. Social mood is impulsive and cannot be stopped. The downtrend will claim its victims by whatever measures it must take to do so.

(August 2009) On July 26, in a speech in Kansas City, MO, Fed Chairman Ben Bernanke declared, “I was not going to be the Federal Reserve chairman who presided over the second Great Depression.” (WSJ, 7/27) We think this implication of a fait accompli is premature. Clearly, the Fed Chairman and the majority of economists are of the opinion that the worst of the financial crisis is past and that the Fed’s unprecedented lending has averted deflation and depression. But wave 3 down in the stock market will dispel these illusions. Years ago, we suggested that Chairman Greenspan quit if he wanted to keep his lofty reputation. He didn’t do it. Now Chairman Bernanke should consider this option.

So will Bernanke serve a second term as Fed chairman? The January 2010 Elliott Wave Financial Forecast says, “Social mood is still too elevated to deny Bernanke reappointment as head of the Fed. … But rising political tension confirms that his next term will be far more stressful than his first.”

Can the Fed Stop Deflation? Robert Prechter answers this all-important question in his Free Deflation Survival Guide. The guide gives you a 60-page ebook that will help you understand deflation and its effects on society; you’ll even learn how to survive and prosper in such an environment. Download Your Free 60-Page Deflation eBook Here.

Why the Fed Likes Independence

Last week it was revealed that when Treasury Secretary Tim Geithner was Chairman of the New York Federal Reserve, he urged AIG officials not to disclose to the Securities Exchange Commission relevant details of agreements with banks to bail out Goldman Sachs.  Apparently he felt at the time that regulators and the public would be angry that taxpayer money was used to fully compensate bankers who made some horrifically bad investment decisions.  These banks should have suffered the consequences of the huge risks they were taking.  After all, they kept plenty of rewards when times were good.  Instead, the Fed found a way to socialize these major losses so these banks could survive and continue making more bad decisions, at the expense of the American people and the value of the dollar.

Geithner claims that they had to take politically unpopular actions to save the economy from collapse.  Half of that is right – it was politically unpopular, but it is extremely premature at best, to claim the economy has been saved.  It was just reported that the economy shed 85,000 more jobs in December.  Unemployment stands at 10 percent officially, and 22 percent according to more traditional calculations.  It is hard to argue that this sort of government waste has done anything but harm to our economy.  Raiding Main Street to bail out Wall Street is a foolish idea.  Main Street productivity and the strength of the dollar is the bedrock of the economy.  You cannot gut this foundation without eventually toppling everything else.  This is what too many policy makers either don’t understand or refuse to face.  Or even worse, perhaps they do understand, but don’t care!

In any case, this revelation makes precisely my point about the need for Fed transparency.  This claim that the Fed should have “independence” is a canard.  They very much enjoy their comfortable pattern of bailing out friends and devaluing the currency with no oversight and no accountability.  Geithner specifically asked officials at AIG not to disclose to the SEC or to the public particulars about this special deal for his friends.  We only know these details now because AIG was eventually forthcoming when Congress demanded some answers.

We should be getting this information, and information on all such dealings, straight from the Fed.  The Fed should be accountable to Congress because it is a creature of Congress.  The Constitution gives Congress the authority to oversee the integrity of the monetary unit.  We have unwisely and unconstitutionally delegated this authority to the Federal Reserve, which has in turn devalued our dollar by 95 percent and counting.  When the Federal Reserve engages in harmful policies, Congress is still ultimately responsible.  If the Fed is not made accountable through a GAO audit at least, it will continue to be accountable to no one, and that is unacceptable.

Geithner expects to be praised and thanked for his actions instead of rebuked and fired.  He expects to be given more power to engage in “experimental” monetary policy in the future.  But he has just given us a very good idea of what the Fed and Treasury would do with more power, what they consider good monetary policy, and why they like their so-called independence.

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The Fed’s Perfect Scenario

If you consider all of the structural problems in the U.S. economy, there has not been a lot of progress toward getting things back on track. The root causes of what created the near debilitating financial and economic crisis still remain:

Banks are still saddled with toxic assets,

Housing prices are still 30 percent lower,

Foreclosures are still hitting new record levels,

Credit is still tight and demand for credit is still contracting sharply,

And now …

The budget deficit has ballooned,

And debt levels around the world have climbed.

The U.S. government has thrown trillions of dollars at the problem. And the actions they’ve taken, for the time being, have helped to avoid a collapse of the financial system that would have caused a massive run on banks, a standstill of economic activity and a worldwide economic depression.

There are plenty of areas to question and debate the decisions made by the U.S. Treasury, the Fed and other government types. But the stabilizers and backstops, to this point, have managed to avert an economic freefall. Of course, the ultimate outcome of policy actions has yet to be determined.

But it’s clear that the U.S. and economies around the world remain fragile.

Even so, people are grasping tightly to the idea that a sharp bounce back is in progress and that a return to normalcy is near.

For the Fed, it’s this type of optimism that is driving a perfect operating scenario.

Government action has averted financial disaster, but global economies remain fragile.

What Is the Fed’s Perfect Scenario?

If the Federal Reserve and the U.S. Treasury could have scribbled out a wish list for financial market conditions last March when global economies and global markets were in freefall, it might have looked something like this …

Wish #1: Please give us rising stock prices.

Rising stock prices improve the sentiment of investors and consumers. They replenish some lost paper wealth and make companies feel better about the future. It’s amazing what a 64 percent rise in stock prices can do for confidence.

Wish #2: Please give us stable interest rates.

Demand is massively depressed by things like evaporated consumer wealth, tight credit, and high unemployment. And deflation has been, and remains, the immediate problem.

The Fed’s answer: Zero interest rates and “printing money.” These tools are at work to prevent a deflationary spiral and to influence low mortgage rates to curb the housing implosion.

But consumer credit and mortgages are priced based on market-driven interest rates, not rates set by the Fed. So a move higher in market interest rates, like interest on 10-year Treasury notes and Libor, would create a big problem for the Fed. It would drive up interest rates on consumer credit and mortgages, which would create even bigger problems for consumers and for the housing market. But that hasn’t happened.

Wish #3: Please give us stable commodity prices, especially oil.

Crude oil is down 50 percent from its high a year ago. In a period where consumers are more inclined to save, not spend … stable gas prices are critical.

Wish #4: And a gradually declining dollar wouldn’t hurt …

This is the icing on the cake. Even if global demand for everybody’s exports is still in the gutter, the effect of a weaker currency on GDP is a nice kicker. A weaker dollar means we import less and perhaps we export a little bit more … but most importantly, the net value that comes from importing less and exporting a little more is a key positive contribution to GDP.

Despite all of the fear about the future of the dollar, it’s important to realize that a weaker currency is actually good for an economy when economic growth is depressed. Our trade balance is narrowing and our current account balance has diminished dramatically.

Now, when the economy is growing at a healthy rate, then a stronger currency is preferred because it helps improve quality of life.

A weaker dollar is actually good for a depressed economy because it helps narrow trade and account balances.

A Gift Without Staying Power

By coincidence, or not, all the Fed’s wishes have come true. And this confluence of gifts from the financial markets has bought some time to address some of the structural economic problems. But the structural problems haven’t been repaired.

Financial markets are rarely compliant to wish lists, especially when the performance defies fundamentals. At some point, the markets will find fundamental equilibrium.

The key question is: When will markets revert to reality?

That’s the hard part.

The U.S. stock market continues to be the gauge of how investors feel about the prospects of a sustainable recovery. Higher stock prices equal more optimism. And more optimism equals higher risk appetite.

But at this stage, the idea of chasing returns that are not supported by fundamentals is a high-risk, low-reward proposition. And it’s not hard to find a reference point of the type of pain that can be associated with the divergence between market prices and fundamentals.

It was only twelve months ago that currencies, commodities and stock markets made sharp and abrupt collapses.

As for the Fed and the Treasury’s wish list … when the rise in stocks ends, so will confidence and any hopes for a sharp economic recovery. And when confidence wanes, investors feel more risk averse.

What Does That Mean for Currencies?

Fears of the dollar’s demise may be premature when compared to other currencies.

Despite all of the ugly issues surrounding the U.S. economy, it will have among the smallest of economic contractions in 2009 compared to other G-7 countries, second only to Canada. And for 2010, the U.S. is expected to outperform all other major developed market economies.

That says something about the state of the rest of the world.

And when it comes to the dollar, and currencies in general, you have to respect the relative nature of currency values. Currencies don’t operate in a vacuum.

A country’s currency is never valued based on how well or how poorly its particular economy is doing in isolation. It’s always measured against another country’s currency. So it is always valued based on how a particular economy is doing relative to another economy.

For those that are fearing darker days for the dollar, remember that the least ugly currency can still win the beauty contest. Also, any rise in risk aversion is a positive for the dollar.

Regards,

Bryan Rich

Fed Promises Easy Money for an Extended Period

by Claus Vogt

Every few weeks the world’s most powerful and influential central bankers — those in charge of the world’s number one reserve currency, the U.S. dollar — come together in what’s called the Federal Open Market Committee (FOMC).

They discuss the economy, interest rates, financial markets and whatever else they deem important. Then they decide to set the Federal Funds Rate at a level they think is appropriate.

And last week was their week. So today I want to analyze what their decisions mean for the stock market and for you as an investor.

The Fed Statement Reassures
A Very Lax Monetary Policy …

The FOMC meets regularly to decide where to set the Federal Funds Rate.

After each FOMC meeting, the Fed releases a statement. And the one for September 23, 2009, is very telling in my opinion. Here’s its most important part:

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

As you can see, the Fed is promising a continuation of its extremely lax monetary policy “for an extended period.” So all the recent media talk about a soon-to-begin exit strategy or a normalization of monetary policy was obviously premature. The Fed is reassuring us that there will be easy money for as far as the eye can see.

Why?

Two reasons come to mind:

First, the Fed is still very concerned about the economy … the employment situation is dire … and a double-dip recession is a real possibility.

Second, and more important, is that they know how precarious the banking situation still is. They know that the bad debt problems have not been solved … that most banks would go bankrupt if they had to implement mark-to-market rules … and that the banking system is still on life support.

This Is Important News
For the Stock Market

Since the Fed is confronted with two major problems — a shaky economy and an unstable banking system — it’s not worrying about a possible stock market bubble in the making.

Why is this so important?

Just look at the charts below. The stock market has rallied some 60 percent since the March low. But earnings are still very depressed. Hence the classic version of the P/E ratio — using twelve months trailing GAAP earnings — shot to the stratosphere!

Source: www.decisionpoint.com

Twelve-month trailing earnings as of the first quarter 2009 were a mere $6.86 for the S&P 500 making for a P/E ratio of 154. According to Standard and Poor’s, these earnings are estimated to rise to $7.51 in the second quarter, and $7.61 in the third quarter. Then they’re expected to jump to $39.35 in the fourth quarter and $43.58 in the first quarter 2010. Based on this last figure the P/E ratio will decline to 24.

Historically the normal range for this very P/E ratio — based on 12-month trailing GAAP earnings — has been between 10 (undervalued) and 20 (overvalued). Hence even if the corporate sector will see the estimated jump in earnings, the stock market is still very expensive.

Classic stock market valuation metrics show that this is a highly overvalued market. And overvalued markets can stay overvalued for a long time and even become more overvalued — as long as the Fed does not take away the proverbial punch bowl.

This means one of two things …

We’re Witnessing the Next Bubble, Or
Earnings Have to Increase Dramatically!

Fed chief Bernanke’s inflationary stance could be the fuel that ignites the next stock market bubble.

Right now I can’t rule out either one. I do, however, lean towards the first. And in reading the Fed’s FOMC statement one thing becomes obvious: If we’re on our way to a new stock market bubble the Fed will not prick it any time soon.

The September 23 statement that I cited earlier is as clear as you can expect from the Fed. Much clearer than anything Greenspan said during his long reign. His famous “irrational exuberance” speech, which was never followed by any action, is a perfect example.

Bernanke is much different …

From the very beginning of his career at the Fed he made it known that he’s a first class inflationist, and he strongly believes prosperity can be achieved by printing money. Now the Bernanke Fed is clearly reiterating this inflationary stance. By doing so the Fed is rubberstamping the current stock market rally and apparently not worrying about a possible bubble!

There is an old Wall Street saying: “Don’t fight the Fed.” I think it’s wise to heed it in today’s environment.

Best wishes,

Claus