Clem Sunter

Poised on a knife-edge

2013-06-20 11:45

Clem Sunter

I am so glad David Shapiro, a leading commentator on stock markets, agreed yesterday on the radio with a point I made in an article over a year ago: Ben Bernanke is the most powerful person in the world as Chairman of the US Federal Reserve, even more powerful that Barack Obama because his words can shift markets all over the world. As I said: "Bernanke has zeroed interest rates to stimulate recovery...if he has got the balance right the US economy will gradually recover...if he has overcooked the brew central banks around the world will start showing enormous losses on their holdings of US treasuries. Whereas the first financial crisis this century was related to commercial banks, the second one will centre on central banks with much more devastating consequences."

Last night shows what a fine line Bernanke is walking. He was quite upbeat about prospects for the US economy in terms of future growth and the unemployment rate falling in the next two years to 6.5% from its current 7.6%. However, while hedging his bets by saying that he would keep all his options open as the figures rolled in, he intimated that the Fed's monthly programme of buying $85bn of mortgage bonds and treasuries might be tapered down later this year and end in 2014. Boom! The Dow Jones Industrial Average fell 1.35% on this news as much of the US stock market's strength recently has been due to zero interest rates driving people to take their money out of the bank and invest it in shares yielding a higher return. This flow of course could reverse if interest rates now start to rise on the expectation that the Fed's artificial stimulus is about to be curbed. Then the bond bubble could burst causing further chaos.

The best metaphor to describe the current situation is to liken the US economy to a patient in ICU. Doctor Ben is betting on the patient now being in a recovery mode such that the tube pumping zero interest rate fluid into the veins is no longer as critical as it was and can gradually be removed. Eventually, the patient will return to normal and be self-sustaining. The stock market, on the other hand, is hooked on the tube remaining in place for much longer and maybe forever. The bulls like the adrenalin rush caused by easy money and they do not want it to end, whatever happens in the real economy. The bears feel that the patient's vital signs, as seen in the regular blips on the heart monitor, may disappear into a flat line following any reduction in dosage. In a funny way, therefore, they both agree that Doctor Ben should carry on without making any suggestion that a change in regimen is in the offing. That proposition spooks everyone.

I cannot tell you who is right and who is wrong about the patient's condition at this moment in time. Can we trust the doctor or not? Nevertheless, we are reaching a moment of truth where Bernanke is either shown to have been a man of great wisdom in pulling off one of the greatest monetary miracles of all time. Or he is shown to have learnt nothing from the failures of his predecessor, Alan Greenspan, who also followed the policy of cheap money but cut off the drip too soon in 2007. Worse still, the drip may be the source of the problem as it offered an easy way out and stopped the patient from reforming his unhealthy lifestyle!



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