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Bernanke must think that things are worse than he's admitting



March 24, 2009 – Comments (18)

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 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?


18 Comments – Post Your Own

#1) On March 24, 2009 at 5:13 PM, QualityPicks (59.97) wrote:

Bernanke knows things are really bad and that is why he is acting like he is. He assumes he can reflate, just like Fisher did. But can you? I think this is why Mish calls Bernanke's policies a "Grand experiment". What I believe is that trying to reflate is like a dog chasing his tail. By trying to reflate, you dig yourself into a bigger hole and then you need to reflate further and further. I personally think we are screwed up and can forget about growth for the next two decades if we keep trying to reflate. If we let market orderly do their work, then, eventually prices get to a point were you can grow.

What is more "painful"? I think letting markets work might be more painful, but that is what I consider fair and just. I think the government should "intervene" but with a good plan to be fair and just that cause markets to orderly crash :) if there is such a thing. For example, the should help setup new banks. That would bankrupt the old ones, but we will be functioning thanks to the new banks. Guaranteeing deposits while banks go under, etc. But to print money and waste billions in bailouts? that is immoral.

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#2) On March 24, 2009 at 6:05 PM, abitare (30.02) wrote:

We have deflation, which is normal considering the extreme leverage and over consumption. We will have high/hyper inflation in food and commodities later.

stagflation- things you own will fall in value, the things you have to buy will rise in cost ie food, gas, water etc. 

Ultimately, the cure to the Keyensian insanity is a war. War will curb consumption, ramp up industry and replace the current currency by decree. Unemployed will be thrown into the fight, and the industrial capaity and populations of rival nations will be leveled. 

That is the cure Keyensian went to last time. Seems likely this time also. 

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#3) On March 24, 2009 at 6:47 PM, MikeMark (29.02) wrote:


The current base money supply (cash) is something like 45 times less than the current credit (debt) supply. In order to have an effect on a 30% loss in the credit (debt) supply, there will probably need to be a creation of something like 15 times the current existing money supply (cash). If the Fed persists in creating money "out of thin air" to the point where it actually appears to have an effect on the deflationary process, they will probably destroy the currency (hyperinflation). That doesn't mean that the deflation stops, it still continues. What happens in that event is that as many people as possible will stop using the  currency in favor of something more stable. The deflation is still there, it just is noticable in a different currency like maybe silver or gold. For those who discount the idea of alternate currency, is it really difficult to exchange your greenbacks for silver?

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#4) On March 24, 2009 at 7:11 PM, checklist34 (98.75) wrote:

negative post:  check

sky is falling?:  check

anyone who is long is an idiot?  I didn't read it all, but I assume thats a check

its a fools rally, any day that any stock moves up is only because someone is stupid?   check?

i mean, absolutely, i mean positively, i mean not even a chance that the sky isn't falling and someday maybe, just maybe, maybe like one in a billion maybe, we'll get out of the recession someday and have, i don't know, a better day than ever before, not even a remote chance, no way, no how, absolutey the sky IS FALLING?  check

apologies in advance if anybody finds the mild sarcasm in this offensive or distasteful, but HOLY HANNAH Caps blog is overrun with sky-is-falling commentaries.  A guy with ANYTHING positive or productive to say gets 3 recs, ANYTHING about how the sky is falling gets 20 recs and a long thread.  Takeover by shorts for political reasons?

Can someone say something productive about what stocks they like and why or what ones they don't and why or what strategies they use and their thoughts on them? 

Or should we all get some gasoline and burn down a hotel beucase, I mean, nobody is ever going to stay at a hotel again after the sky falls?

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#5) On March 24, 2009 at 7:14 PM, Imperial1964 (95.07) wrote:

I don't have a strong opinion on this one right now.

But I do wish I had learned long ago to short the rally immediately following Fed or Treasury intervention.  Your we don't yet know what they know theory has certainly held up so far.

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#6) On March 24, 2009 at 8:25 PM, abitare (30.02) wrote:


I ignored the China run up,  Fools were always babbling about the BRIC story 18 months ago. I ran with the commodity bulls, and got out before the collapse. I have shorted the US market for the 40% collapse. 

I am currently long SWHC. It is up 100% since I told you Fools I was long the position on 17 Feb 09. 

The problem most Americans are having is the same problem you are having. You are a "buy and holder" aka"buy and hope". "buy and hope" has lost 30-40% in stocks, 30-40% in real estate and 30-40% in deflation in the dollar purchasing power. 

It is not the bears/opportunist that are "doom and gloom", it is the "buy and hopes" are miserable. They are realizing they have been sold a bunch of lies and miss information. So they try and insult the others as "doom and gloomer".

I have been stomping on "buy and hopers" dreams for over a year now. I will hold my "doom and gloom" portfolio strategy to any "buy and hopers" out there. 

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#7) On March 24, 2009 at 8:59 PM, rookie02 (52.88) wrote:


While i would normally agree that you are right to point at chicken little and laugh until you cant breathe and tears are streaming down your face, there are a couple of key things that have not been mentioned. Both China and Russia are suggesting the creation of a new world currency, something more "stable" than the dollar, they are very public about this, and if say china was to dump a couple trillion reserve cash worth of american dollars, while we are printing a couple more... i mean... come on! The depression was experiences with the british lb standing as the "world" standard, gold backed and credible. What is the american dollar being backed by these days? huh? a promise? Its backed by Individuals having good faith that this slip of paper will have an equivilent value of a type of good, and while it may go back and forth a bit, i can still plan accordingly without fear of waking to saturday morning cartoons and a bank account number that represents the equivilent of monopoly money. If you are not concerned about the future of the american dollar, you are either ill informed or know something the magority of us do not.

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#8) On March 24, 2009 at 9:17 PM, throwerw (28.42) wrote:

long BBEP.  oil and gas exploration and production master limited partnership with 85 percent of production hedged through 2012 around 80-90 bucks for oil and 8 bucks for gas.  i'm thinking that at some point in the next four years, oil and gas will be back at or above those ranges, and bbep will hedge another five years out.  yield is around 30 percent, so there is a good chance you get all your money back through distributions alone in 3 years.  not to mention the stock is trading at a significant discount to proven reserves.  also, a lehman hedge fund once held 10 percent of it and had to dump it all after bankruptcy, seth klarman took advantage and picked up 15 percent of the company, and heavy insider buying started around 15... we are now at 7.  intrinsic value is very conservatively 24.

LINE is also worth a look.  they are one hundred percent hedged, same deal with the lehman hedge fund, and the yield is around 20 percent.  bbep is a better bargain though

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#9) On March 24, 2009 at 10:14 PM, russiangambit (28.88) wrote:

Inflation is the only politically acceptable way out of the current trouble. Another, I guess would be to cut spending on every government level to the bone, like 50% and put tax to the debt repayment, lets the underwater financials collapse, but it is simply not feasible. Plus, that second approach still doesn't solve the deflation issue, but only worsens it.

So, inflation it will be. I came to this conclusion a couple months ago. With inflation, there is transfer of wealth from creditors to debtors. I have a big problem with that since I am a saver by nature and it irks me that the government is doing everything it can to devalue my savings.

Anyway. following this theory I reduced my mortgage payments to the minimum. I put my cash into stocks and commodities, since those will rise in monetary value, if not in real. I am thinking about refinancing to lock in 4.5% since and digging a pool while I am at it. -)) If inflation is coming, the best thing you can do is to run up debt right now (putting in money in things that are going to keep their real value), lock in low interest rate and then let that debt fall in real value.

Actually, this is what is probably behind the recent rally in stocks. People see the inflation coming and they are trying to preserve capital by putting it in stocks.

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#10) On March 25, 2009 at 1:12 AM, bbbengggriffin (25.54) wrote:


Thanks, great post.  Deflation certainly seems like the more daunting of the two evils, but I share your distrust of the government's ability to deftly weild any power, much less, the somethign on this scale.



Albitare has great advice, worth considering....

And.... if the sky is falling, it is important to tell everyone.

Money can be and is being made in the market right now.  Caps has some restrictions that don't apply in real life...  Here are some ideas that are worth some time reviewing for real dollars.

















These are behaving well or beginning to behave well, for the most part.  The last 4 are CEFs trading for significantly under NAV.... and headed int he right direction.... It is so nice when you can buy AAA AA and A rated debt at a 15% discount (TYW).



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#11) On March 25, 2009 at 1:40 AM, RainierMan (64.48) wrote:

Deflation now, but inflation is coming, it's just "when"?. I believe the U.S. will try to inflate it's way out of this. It's not that the Fed KNOWS all hell is about to break lose. Nobody really can see out 9 months with clarity. It's that the Fed knows we ultimately must inflate our way out.

And DO NOT underestimate the ability of MUCH of the population to start buying again. It's in our blood. We love to consume. Some no longer can, but many can, and will.

Because I don't know the timing of it all, I keep things short term. 

I think the bond strategy is pretty reasonable, though I admit that I am too concerned about where interest rates could be headed to put much in bonds.

I'm mostly cash, but playing rallies. This is not terribly difficult to make the volatility work.

I keep looking for good stocks dirt cheap. I mean really cheap. WBC is one, which has been doing well. I could hold it long term or short term with a stock like that. 

Small amounts of money to play the short term euphoria of "the sky will never fall" types: C, UBS, GE and DRYS for example. I said small amounts of money!

Gold on dips has been nice. I don't get greedy.

Small amounts of money, in diverse assets, taking profits when they are in the 20-50 percent range, cut the losers if your thesis seems flawed. Keep them if you think they'll ultimately work. Don't get wild. 



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#12) On March 25, 2009 at 5:05 AM, jester112358 (28.20) wrote:

Deflation (next year or two)/then major inflation. 

After the greatest credit expansion in human history only a credit contraction is really possible to re-establish equilibrium.  This will be credit/debt deflation.  Savings and debt reduction in the new paradigm in the private section.  Cash will be king and being debt free for individuals and companies will be key (think AAPL with 25% of the share price in cash)  Even the government can only affect the time scale of this natural contraction in credit/debt.  A short, highly tramatic unwinding of this bad debt would be preferable to a drawn out, make believe everything is alright affair as in Japan for the last two decades.  However, demand/supply issues still apply to real things like food, energy etc.  Thus, I am heavily into fertilizer/food suppliers like POT, TNH, TRA and domestic energy suppliers like XTO, APC etc. since the probability of major war in the mid-east is still very large and there is no replacement for fossil fuels.

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#13) On March 25, 2009 at 6:23 AM, TMFDeej (97.76) wrote:

Checklist, perhaps you should actually read some of what I wrote before you go off and start criticizing.  I wrote a bullish piece on a stock, FPL, a few hours ago that got nine recs.

I did not say that the sky is falling and that we are all doomed.  I said that I am trying to decide whether we are headed for inflation or deflation and at the end of my piece I provided actual investment advice and an example of how I am investing my money in this environment.

Read before you criticize.


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#14) On March 25, 2009 at 9:14 AM, floridabuilder2 (98.23) wrote:

Bernake knows we are in a death spiral that is why the govt is offering loans to bid on assets.. because those bids will come in higher due to the leverage and I know you understand ROE when it comes to leverage....  Wall Street does not work on a cash on cash model but on MOI and IRR and these returns are allowed to be influenced by leverage..

Most people know that true returns are garnered by unlevered investments....  Most of the toxic securitized assets are owned by the big 4 banks which control 56% of bank assets.... those assets will come flying off and probably 3 of the big 4 banks will be saved....

I think the govt wants to save the biggest banks by injecting tax payer money... this allows PE to overbid for toxic assets it also allows the big banks to write off consumer debt quarter by quarter....

I believe that many hard land and building assets will be remarked to much lower levels dropping the fixed costs of people (homes) and businesses (property and buildings).... this will stop the crowding out of profits and wages...

this process will go on for multiple years and as one by one consumers default on debt the banks can absorb it because they are getting taxpayer money and these clean sheet consumers then have to start using cash to go about their daily lives....

In the end I think stabilzation occurs because enough money will be pumped into the largest banks and the wealth funds will make boat loads of money for those who invest with them thus creating or reinflating your retirement nest egg

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#15) On March 26, 2009 at 11:02 AM, EHoyle80 (< 20) wrote:

If, as the Stock Research Portal claims, the economic policy of Obama and Bernanke is throwing mud against the wall in hope some of it sticks, then the pertinent question becomes, “Does the U.S. have enough real (as contrasted to ‘fiat’) ‘mud’ to keep experimenting with while the process continues to ‘socialize’ its capitalist system?”

Via Stock Research Portal

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#16) On March 28, 2009 at 8:10 AM, wuff3t (99.64) wrote:


Without wishing to put words into someone else's mouth, my guess is that checklist34's response was more general than specific, ie probably driven by the overwhelmingly negative tone of CAPS blogs these days.

For what it's worth I think MichaelinWA makes one of the most insightful remarks I have read in some time: "It's in our blood. We love to consume..."

Every economy is based on people consuming. That's what really moves money around. So governments the world over will make this their primary concern, sooner or later and one way or another. We are moving closer to a global economy, and it benefits no-one if the world's consumers stop spending what little they have. My suspicion is that the mess we're in will be prolonged and perhaps in many ways worsened by the interventions of the various major powers' governments. However I also think that somehow governments will find a way to ensure that consumers continue to spend in order to prop up the major economies. Hence I think money will continue to be made.

How am I investing? To be honest I haven't altered my strategy one bit because of the current crisis. Perhaps I have my head in the sand but I've always preferred the long-term buy-to-hold approach, and am 25 years away from retirement (unless I get lucky) so I'm sticking with my policy of trying to pick companies that will still be around - and stronger than ever - in at least 10 years time (preferably longer).

I recently opened my first position in BRK and am looking to buy more. If anyone knows how to make money in a market like this, I'm prepared to bet it's Mr Buffet.

Well, he has more chance of getting it right than me, anyway...:-)

Wishing you all good fortune...

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#17) On March 29, 2009 at 9:47 AM, arboretum (28.03) wrote:

I opened a small position in BRK-B and was stopped out of it quickly. Buffet may be smarter than many corporate execs, but his company had lost correspondingly little value and was overdue a correction. More may follow.

I am currently avoiding putting large stakes into single companies. Most of my money is in GCS (commodity ETF) and OIL. I also have some CAT, WFC and BAC bought at what I hope is the bottom, if not I will stop out before I lose. My thesis is YES we will have inflation, therefore it is good to own STUFF (oil, commodities) and good companies that are challenged by debt problems but unlikely to go under anytime soon.

I am afraid of "senior" corporate bonds because look how many of 2007s "senior" companies have defaulted. I am afraid of treasuries because of "quantitative easing". I am afraid of GLD because it seems overbought right now and often spikes at times like this, although it is a good swing trade. I am not afraid of OIL because I think it has already been deflated and even without inflation will slowly rise over the next year or so. If the dollar is devalued it may spike.

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#18) On March 30, 2009 at 6:26 AM, TMFDeej (97.76) wrote:

Thanks for reading, arboretum.  The term senior does not refer to the quality of the company.  I pay very little attention to what ratings agencies say about the shape that companies are in.  Senior refers to the fact that a bond is at the top of the ladder within the bond structure.  Bonds get paid back before common and preferred stock in the event of a meltdown in a company and senior bonds get paid back before junior bonds.

Very few companies have defaulted on their bonds lately.  Even the most messed up ones like Fannie, Freddie, BofA, Citi, AIG have continued to make bond payments throught this whole mess.


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