Bernanke must think that things are worse than he's admitting
Perhaps I'm being naive, but I just cannot bring myself to believe that the folks at the Federal Reserve in general and Ben Bernanke in particular are stupid. I suppose that it's possible that they are book smart, but street dumb and that they cannot practically apply any of the theories that they memorized at their fancy Ivy League MBA programs in the real world. I certainly have met enough of those people over the years.
Let's just assume for a second that the folks at the Fed aren't complete idiots. If that is the case, then Ben Bernanke had to have been likely lying in an effort to avoid creating a panic and causing consumer confidence to fall even further when when he stated in his recent 60 Minutes interview that he believes the worst of the recession will be over this year and that we will experience a healthier economy next year.
I'm calling BS. There's no way he believes that the recovery will be that fast. If things do stabilize before the end of the year and we do see a return to growth in 2010 then hold on to your hats because the United States is likely going to see some wild inflation. Regardless of whether he is right or wrong about where the economy is headed, to me it's clear that Bernenke believes that things are worse than he's letting on in public.
Actions speak louder than words and the Federal Reserve's recent actions, such as lowering the Federal Funds rate to zero and then pulling out the big guns and engaging in quantitative easing by purchasing Treasuries to bring interest rates down even further, suggest to me that Bernanke believes that the U.S. is headed for The Great Depression II if we don't take drastic action ASAP.
The man is a student of the Great Depression. I suspect that he believes that we are in the midst of what Irving Fisher described in his 1933 book "The debt-deflation theory of Great Depressions." In short, Fisher's debt-deflation theory states that two main factors create terrible depressions. They are:
"Namely over-indebtedness to start with..." CHECK
"...and deflation following soon after." This is what The Federal Reserve is trying to avoid.
Fisher believed that deflation at a time when there is a high debt level creates self-reinforcing deflationary spiral that is very difficult to escape. As deflation takes hold, every dollar of debt becomes more and more difficult to repay, to the point that the liquidation of the debt (which is happening pretty darn slowly right now if you ask me) cannot keep pace with the rapidly falling prices.
So how did Fisher propose that one avoids falling into such a trap? On the subject he said: "It is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors... I would emphasize... that great depressions are curable and preventable through reflation and stabilization."
This is clearly what the Fed is trying to do right now. They are using every trick in the book and even making up new ones to try to reflate the economy as quickly as possible. They wouldn't be cranking up their Inflation Death Ray to full power if they didn't think that things were still completely screwed up and not getting any better without taking drastic action.
The obvious question at this point is...is Bernanke's secret theory that the economy is a still a mess with no recovery in sight correct or is he overestimating our problems in which case the U.S. will race out of this recession and into an inflationary nightmare? In short, are we headed for deflation or inflation?
A strong case can be made for both sides.
If the Fed's actions are successful, we could be headed for an inflationary mess.
If not then we could be headed into a deflationary spiral.
Neither result is good, but the seem more likely to me than the Treasury, Fed, Congress, etc... actually doing something right and helping the economy glide to a nice safe bottom from which it will slowly ease back into growth mode again. To me the odds of that happening just don't seem very high.
I still am not sure whether we will be in an inflationary or a deflationary environment in 2010 and the investment strategies for both are significantly different. I think that I am personally leaning towards the latter combined with an extended period of slow to no growth, but I certainly am not positive that's what will happen.
For now I am trying to keep an open mind and I am trying to play both sides with my investments. I am investing in the safest asset class that I can find, senior corporate bonds. However, I am looking for situations that provide attractive yields (in the 7% to 10%+ range) and that have close maturity dates (2 to 10 years in most cases). Unless inflation begins to rage out of control and/or foreigners lose their appetite for Treasuries and yields shoot straight up, these 7% to 10% yields-to-maturity are pretty darn solid. In the event that we do experience crazy inflation, I have only locked in my money for a couple of years. This will enable me to comfortably hold my bonds to maturity and not be forced to take a loss on them by selling them on the open market.
Where do you think that the economy is headed and how are you investing right now?