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Last updated: January 31, 2014 6:28 pm
“We did what we did, we didn’t do what we didn’t do, and the result was what happened.” – Paul Volcker
Ben Bernanke is entering history. The work of writing a eulogy to the eight years of turbulence that he oversaw from the Federal Reserve can now begin.
Beware, however, that early judgments of Fed chairmen have even more of a tendency for revisions than economic forecasts. And they are bedevilled by our lack of knowledge of the counterfactual – we never know what would have happened if the Fed had done something else.
Thus when Mr Volcker left, he was widely seen as an imperious technocrat who had unnecessarily inflicted a recession on the US in an aggressive crusade to beat inflation.
He is now almost universally respected as a decent man who had the courage to break inflationary forces that had built up for decades, and created the conditions for the prosperity that the US enjoyed in the 1990s.
Alan Greenspan, his successor, left office known as a “Maestro”, to cite the title of one book about him. But barely a year after he left office, in early 2006, his reputation was in shreds, as he was widely reviled for bailing out companies and encouraging risk-taking, while keeping rates far too low for far too long, and encouraging the growth of the credit and housing bubble.
Where will Mr Bernanke rank? Judging by my email inbox, and the tenor of comments left on FT.com, he is truly hated by many in the financial markets.
But it is too soon to judge his signature policy, the quantitative easing bond purchases with which he fought the risk of deflation. Many say this will eventually lead to hyperinflation (there is no evidence of this yet), and stoke deeper economic inequality (for which, alas, the evidence is already plentiful). Judgment must wait until the Fed finally tries to return to more normal monetary policy – an event that may still be several years away.
Many suspect that growth will falter, and asset prices tumble, at that point. If this does not happen, the policy will probably be seen as a success. How to gauge the probabilities?
Handily, prices in financial markets embody forecasts on this issue.
The market verdict as Mr Bernanke exits is that he has done a great job. Markets are braced for growth, stable inflation, and no great stress in the financial system
Over Mr Bernanke’s eight years, as the chart shows, equities narrowly beat Treasury bonds. House prices, as measured by the Case-Shiller index, were much lower at the end of his term than at the beginning. Miscalculating the housing market may have been the Bernanke Fed’s key error.
For inflation, which has fallen slightly during the Bernanke term, break-even rates derived from the difference between fixed and inflation-linked bonds predict average inflation of 2.3 per cent over the next 30 years, and 2.15 per cent over the next decade – so the bet is on that both hyperinflation and deflation will be avoided.
What about growth? Look at price/earnings ratios on stocks. The higher the p/e the higher the hopes for growth. At 16.6 the p/e on the S&P 500 is almost exactly where it was when Mr Bernanke took over.
As for America’s position in the world, the S&P 500 has outperformed FTSE’s index of the rest of the world by 23.4 percentage points in the Bernanke era. Has that been achieved at the expense of other countries, as some now allege? Possibly. It looks like the US has effectively exported inflation to the emerging world. Against that, remember that the Fed leapt in to offer cheap dollars to a number of emerging markets in 2008. Mr Bernanke took political heat for this at home, but it was vital in averting an all-out emerging market collapse; he did not ignore the rest of the world.
Ten-year bond yields were just under 5 per cent eight years ago, and are now under 3 per cent – so faith in the credit of the US government remains intact, despite some interesting political adventures along the way.
Are people nervous about the future? The TED spread, measuring the gap between overnight bank rates and T-bill rates, a core measure of financial stress, is also almost exactly where it was eight years ago at 22 basis points (having been as high as 463bp in 2008). There is little worry about the banking system’s health.
So, are markets really confident that the Fed under Janet Yellen will be able to exit from QE without incident? No. Banks’ share prices are far lower than they were when the Bernanke era started, while the gold price remains far higher. On both measures, confidence is returning, but plainly distrust in the US financial system remains.
With that important caveat, the market verdict as Mr Bernanke exits is that he has done a great job. Markets are braced for growth, stable inflation, and no great stress in the financial system.
If equities today are proved in the fullness of time to be correctly priced, then Mr Bernanke will go down in history as a great Fed chairman. But then, as he entered, these measures also showed confidence that Mr Greenspan had done a great job. Fed chairmen can make mistakes. So can markets.
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