October 4, 2011

In testifying today before the Joint Economic Committee, the Fed Chairman made predictable remarks, indicating that the central bank has not exhausted possible steps to support the U.S. economy but stressing that fiscal policy and other actions for which the Congress is responsible are more appropriate and effective avenues to be pursued.  Nor was the additional assertion that the recovery has been shallower than hoped a surprising revelation.  The FOMC said as much in its September 21st statement that identified “significant downside risks” to growth.

The main message to take away is lies not in the substance of what Bernanke said but in the poor reaction of investors today, which follows a pattern of selloffs when he’s spoken publicly on other recent occasions or for that matter after public remarks by other authority figures like Obama or Trichet.  The crisis of confidence represents more than fear about current economic conditions and prospects.  Despair extends to the competence and intentions of democratically elected governments in all advanced economies. 

The downward spiral of emotions after the subprime mortgage meltdown was halted in the early spring of 2009 by a coordinated and forceful policy stimulus from developing and developed economies alike.  With hope then restored, share prices and bond yields in the United States and Europe did not follow the the full path taken by Japan some 15 years earlier.  If hope does not return this time, however, investors will increasingly associate the realm of possibility with Japan’s earlier experience.  From a peak at end-1989 of 38,816 in the Nikkei-225 to 8,456 today would be equivalent to an eventual drop of the DOW from 11,723 at the end of a 17-year bull run on January 14, 2000 to 2,547 some time in remainder of this decade.  Because they started from a higher level than the comparable Japanese Government Bond (JGB) yield at end-1989, U.S. Treasuries have already declined further since end-1989 than the 474-basis point drop in JGBs over the same period.  Ten-year Treasuries had a yield of 7.88% at the end of the 1980s but are now less than a percentage point above Japan’s lowly level.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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