Fagan Associates Archive for November, 2010

In a prepared speech as part of a Panel Discussion at the European Central Bank focusing on the topic, “Emerging from the Crisis:  Where Do We Stand?” Federal Reserve Chairman Ben Bernanke addressed some of the issues and concerns impacting the U.S. and Global Economies.  The panel discussion took place at the Sixth European Central Bank Central Banking Conference in Frankfurt, Germany.

Why is this important to you, the investor?  Quite simply, historically double-dips in the economy (recession-recovery-recession shortly thereafter) are caused by either monetary or fiscal policy mistakes and given the fact that the Federal Reserve controls monetary policy, we thought it would be a good idea for the reader to be familiar with what the thoughts are of this body.

Early on within this speech, Chairman Bernanke succinctly outlines the state of the global economy noting that “although the efforts of central banks to stabilize the financial system and provide monetary accommodation helped set the stage for recovery, economic growth rates in the advanced economies have been relatively weak….In the United States, we have seen a slowing of the pace of expansion since earlier this year.  The unemployment rate has remained close to ten percent since mid-2009, with a substantial fraction of the unemployed out of work for six months or longer.  Moreover, inflation has been declining and is currently quite low, with measures of underlying inflation running close to one percent.  Although we project that economic growth will pick up and unemployment decline somewhat in the coming year, progress thus far has been disappointingly low.”  In our words, “central banks around the world helped the global economy avert an economic disaster.  However, we are trying to emerge from the deepest recession since the Great Depression and although we do see some improvement, the progress has been painstakingly slow.  Furthermore, forward economic momentum is waning which is a cause for concern.”

In addition to lowering interest rates, the Federal Reserve has other arrows in its’ quiver, including Quantitative Easing, which it has begun to embark upon, where the Fed purchases Treasuries and other Government Agency Debt I the open markets thereby injecting cash into the economy.  Accordingly, the Fed recently announced its “intention to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.”  In our words, “the Fed needs to get the economy moving again or we risk a double-dip.  We will try to do this by injecting cash into the economy in the hope that credit loosens up and the economic wheels begin to turn at a faster pace.”  Keep in mind that despite the fact that the Fed can add liquidity to the economy they cannot force banks to lend or consumers to consume.  This has been the problem.  The velocity of money or the rate and times which money changes hands or turns over in society has been slow.  There is enough money around, but individuals, corporations and lending institutions are holding onto it, thereby helping nobody.

Finally, Chairman Bernanke addresses some of the potential problems impacting the ability of the global economy to recover noting that “tensions among nations over economic policies have emerged and intensified, potentially threatening our ability to find global solutions to global problems.”  In our words, “currency and trade wars have the ability to derail this nascent global recovery, a la, President Hoover during the Great Depression.  Should we let this happen, the repercussions will be severe and perhaps long-lasting.  Let’s do our part to help avoid this, China!”

THE BOTTOM LINE – Chairman Bernanke realizes that although recovering, the U.S. Economy remains in a fragile state, a state in which consumer demand is low and unemployment high, as are tensions both at home and abroad.  With this in mind, the need to do the right thing is more crucial now than ever.  We think that Chairman Bernanke and the Fed believe that this includes reflating our way out of this economic malaise.  We agree.  Avoid deflation at all cost.  Look at what happened to Japan when it did not do this.  For individual stock and equity mutual fund investors, we believe this will bring higher prices.  For bond investors, beware.  If Chairman Bernanke is successful, higher interest rates, perhaps on only a gradual basis, are on their way.