What Ben Bernanke should be asking before his speech at Jackson Hole is "How did I get here?"

25th August 2011 by Shaun Richards

Tomorrow comes an event which has been awaited ever since the American economy showed yet more signs of a slowdown. This is the speech that is going to be given by the Chairman of the Federal Reserve Ben Bernanke at Jackson Hole. Expectations are high for what he might say and markets have suddenly become very volatile again. For example we have had a day this week where the US Dow Jones Industrial Average has risen 322 points and yesterday we saw the gold price fall by US $105 after reaching a new high on Monday of US $1917 in terms of front month futures. And yesterday we saw US ten year bond prices fall and yields back up to 2.27% only a week after they have fallen below 2%!

So in a week where because of us being in the holiday season there is less news flow than might be normal we can look to expectations for tomorrow’s speech as a cause of much of the wild swings. Some market participants are clearly hoping that Ben Bernanke can pull the equivalent of a conjurer’s trick and pull a rabbit out of a hat and that furthermore the rabbit will metamorphose into the Easter Bunny. He made substantial announcements at the same speech last year which the Federal Reserve then backed up with more further action in November. So I guess many are hoping for a type of deja vu.

However rather than discuss what he might do I wish to take a leaf out of David Byrne’s songsheet and ask.

How did I get here?

If we go back in time I made a prediction for 2011 in the title of my post on the 22nd of December 2010.

Inflation and deflation are likely to be the joint themes for 2011

I realise that much of the media are imprecise in their definitions so let me point out that deflation strictly means a fall in aggregate demand in an economy and more loosely can be used to describe a sustained decline. So let us take a look at what has happened.


We saw in the early part of 2011 a surge in commodity prices as well as in the price of oil. This has been a contributor to the rise in consumer price inflation that has been seen in so many parts of the world. If we look at official inflation indices we see that the United States has hit 3.6%, the Euro zone is at 2.5%,the UK at 4.4% , China at 6.5% and India is at 9.22%. So we can see that the inflation upsurge is widespread and has led to inflation being over target in wide sections of the world.

The upsurge in food prices also had the effect of making it unaffordable for some of the poorest and to my mind was a contributor to the Arab Spring and other unrest around the world. For those who have follow my updates the foodstuffs component has drifted back from the highs of earlier this year but at 501 is still substantially up on where 2011 started.


One influence here has been  as I expected

Plainly the peripheral nations in the Euro zone are an example of a deflationary influence with Greece and Ireland clear example of this and Portugal is in a situation where she too is in an unsustainable position. (This was several months before Portugal asked for help.)

To this I added the prospect of “Contagion for Spain and Italy.” These matters have come to pass and if we view the recent economic growth figures we can see that it is not only the periphery of the Euro zone that is slowing down as for example in the second quarter of 2011 France had no growth at all. If we stick with France and look forwards it was only yesterday that she reduced her official growth forecast for 2012 to 1.75%. As official forecasts these days are usually somewhat rose tinted I think the reduction is of more significance than the new forecast.

If we step back in time to December 2010 many economists at places such as Goldman Sachs were telling us that the fiscal stimulus just incepted combined with the monetary stimulus of QE2 would lead to economic growth of over 3% and the more excitable predicted 4%. In reality we got an annualised rate of 0.4% in the first quarter and an advance estimate of an annualised rate of 1.3% for the second (which may well get revised down tomorrow). Accordingly the US has fitted a general deflationary story too.

My own country the UK has rumbled on in a stagflationary pattern where growth after the shock fall in the last quarter of 2010 has been rather insipid. I obviously did not know that Japan would be hit by a tsunami but in the event it has now been in recession for three quarters of a year.

Other parts of the world have recorded much better figures but there have plainly been deflationary influences as indicated above.


As you can see from the detail above the question, how did I get here? poses real problems for Ben Bernanke and for those who feel he has the ability to improve the world economy. He must review the results of his actions with dismay. If we were able to borrow Doctor Who’s Tardis and go back to 2003 when he wrote his economic paper on what central banks could do in the situation he now finds himself in he was full of optimism and bombast whereas reality has proved much more inconvenient.

Our results provide some grounds for optimism about the likely efficacy of nonstandard policies

So tomorrow he must feel under pressure as he knows if he is honest with himself that events have not turned out as he hoped. This is before we get to the opinion of those such as me who have argued it was always likely to fail as presumably Ben did actually believe in it. Thus we are in a dangerous position as he is under pressure to “do something” when his  ammunition locker is looking pretty empty.

This is why those who examine events are coming up with some recommedations out of left field such as Bruce Krasting’s suggestion that central bank swap lines could be opened on a substantial scale. As this is an area not well covered in the media I have written an explanation guide for this subject in the Explainer section of this site. However if Ben remains true to the paper I have quoted above there is some room here.

changing the composition of the central bank’s balance sheet through, for example, the targeted purchases of long-term bonds as a means of reducing the long-term interest rate

If you read of Operation Twist in the media then it comes under that category. However let me give you a word of warning as many seem to treat talk of Operation Twist 2 or Let’s Twist Again (sorry!) as a type of Holy Grail. This rather ignores the fact that the original Operation Twist failed…

Yet more problems in the Euro zone

I have written twio updates on this general subject already this week discussing problems for Greece and the European Central Bank. Yesterday we heard this from the German President.

I regard the massive acquisition of the bonds of individual states via the European Central Bank as legally questionable

As you can imagine such a statement poses a lot of questions particularly as it comes hot on the heels of criticism of such purchases from the German Bundesbank. Next month will see such matters be debated in the German Constitutional Court and those who have taken their case to it will feel emboldened by the President’s comment.


The ability of the Euro zone to score own goals seems almost never ending. This latest problem comes hot on the heels of the debate about collateral on loans to Greece which I discussed on here only on Monday. The joint effect can be seen on the Greek government bond market where prices have fallen and yields risen. The two-year maturity now yields over 44% and the five year over 22%. Remember it was only just over a month ago that she had a new bail out package.

If you look at the two year bond you would receive more in interest than par value of the bond (100) if you reinvested the interest. The “rub” as Shakespeare put it is that it actually has to be paid and the price is plainly putting a lot of doubt on that.

Another way of looking at the calamity of the situation is simply to look at the price of the Greek ten-year bond. It has fallen below 50 again which means that in spite of the backing of the EU,ECB,IMF and the Greek government and their new plans we are back to real fears of default again.

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16 thoughts on “What Ben Bernanke should be asking before his speech at Jackson Hole is "How did I get here?"”

  1. James says:

    Very interesting contrast between The USA and Europe. Whatever the rights and wrongs of Bernanke’s policy making, he can at least make policy.
    In contrast, there does not seem to be a way of making policy which sticks in Europe. Whatever one thinks of the Finns for demanding collateral, can you imagine, say, Oregon demanding collateral or being able to block a Fed action? Or California challenging the Fed’s right to act?
    We seem to have managed to get to a situation in Europe where the single currency has ended up in disaster for several countries (for varying reasons), but the political constitution cannot really cope. Many countries want to be part of that currency union and pontificate grandly about European visions etc, but, when it comes to hard cash, they revert to being individual countries. I see no way out.

    1. Drf says:

      Hi James, as you comment here Bernanke has been given the authority to “make policy”, without being elected by those he is able to make policy over!  Herein is a remarkable similarity with Europe in that the EU Council of Minsters and the ECB have also been given the authority to make policy and they also are unelected by those they make policy over.

      We then fool ourselves that The West has “Democracy”, and we fight wars to force other countries to impose our form of “Democracy”!  Something seems to have gone very wrong, and intense deceit prevails.

      1. James says:

        Very fair points indeed. At least the Americans can throw out the politicians who appoints Bernanke. We seem in Europe to be another step away, as there seems to be no plausible way of changing the guard in Europe. For example, would you even know how Van Rompuy or the even worse Baroness Ashton could be removed? I have no idea…

        1. Anonymous says:

          This will be the downfall of the EU in the end, the lack of democratic control and the self-appointed nature of the posts. Who, for example, agreed that Merkel and Sarkozy could decide financial policy for the Eurozone, at least? What happened to J-C Juncker, no genius himself, who was said to be the head of the Eurozone finance group? 

          Something is fundamentally wrong when the interests of 2 individuals representing (?) 2 countries can ride roughshod over at least 15 other countries and probably 25. This will not end well.

        2. Anonymous says:

          I agree with you and DRF. However I am cautiously optimistic that the German political system is slowly reacting to Merkel and her EC partners in crime – by that I mean the illegal violation of the Lisbon treaty. From Austria, Finland and Germany to the Netherlands domestic politicians are acting to prevent further waste of taxpayers money. This is a quiet revolution in countries where an uncritical pro-European consensus has ruled for decades.

          The German constitutional court ruling on the bailout could have interesting consequences – it may make for an exciting week in the markets when the verdict is delivered.

    2. Anonymous says:

      Yes, he can make policy but that doesn’t seem to be doing any good at all.   The policy seems to co ordinate the destruction of other peoples.    The only thing going for the US over EU is the reserve currency situation, and how long that will last is moot.

  2. Anonymous says:

    Any discussion of Bernanke should bring in two other names, Henry Paulson and Tim Geitner. The three were the architects of the response to the events of 2008. Central banks have now become stabilisers ( not lenders) of last resort to financial institutions and their markets. Instead of trouble-shooting, they are underpinning markets and risking fiscal capture. The ECB is out of step with this North Atlantic alliance as the BoE appears to be in the Bernanke mould. Here lies a real friction.

    1. Anonymous says:

      Hi Shire

      There was another echo of 2008 today with Warren Buffett investing in a US banking institution. I think the echoes of what happened next then have undone some of the benefits of the cash injection to Bank of America…

  3. Anonymous says:

    Money is not everything. In Greece we are happy
    I am personally happy with my life: Greece 80%, UK 72%, Germany 61

    1. Anonymous says:

      I guess the song for this is “Don’t worry be happy” By Bobby Mc Ferrin I think.

      I did take a look at the link and the 96% for Denmark has echoes of a sort of Stepford wives syndrome does it not? Can you get 96% of people to agree on anything……

  4. daniel.chisholm says:

    Shaun you write “…that central bank swap lines could be opened on a substantial scale. As this is an area not well covered in the media I have written an explanation guide for this subject in the Explainer section of this site.”

    I wonder if you might post a link to this, it sounds interesting (I haven’t been able to find the Explainer section of this site, I suppose it is right under my nose though!)

  5. Robert Silver says:

    Martin Weale, member of the Bank of England’s monetary policy committee, has given a speech in Doncaster, UK, saying that the BoE could restart QE if oil prices continue to fall and the sovereign debt crisis in the Euro zone continues.  

    Can anyone tell me how oil prices falling has anything to do with QE restarting?  Surely that’s great for the economy and people will possibly fill up their tanks with more petrol, and could, if anything, help push up inflation.

    Please excuse the question, as I’m nowhere near being an economist and just happen to find the blog extremely insightful, if a little over my head (often!).

    1. Michael says:

      I was interested in this too, but no ‘expert’ seems to be available!!
      Clearly the ‘UK establishment’ are absolutely scared stiff of any hint of oil or other comodity reducing in price as this would cancel out their induced inflation.
      UK government in league with the non-independent BoE, plan to continue to stoke inflation as much as they dare for as many years forward as possible. This is the only way to bail out the banks and reduce government borrowings (national debt).
      Any threat to this policy will be attacked with money printing (QE). The key is to keep the £ low and falling against every other currency, and they even manage this against the Egyptian £ and Zimbabwe $ !!!
      However they will come unstuck for one very good reason, and I challenge anyone to point out what will quickly happen to spoil their party if they do introduce more UK QE??

    2. Anonymous says:

      Hi Robert

      I have only seen some highlights of the speech but the conventional Bank of England story is that inflation is exogenous to them. By that I mean that they keep claiming it happened and they had nothing to do with it. However even most of them realise that it is currently too high to have another go at QE. Accordingly they hope for signs of lower inflation going forwards of which a signal would be a lower oil price…..

      Also they need real evidence of a slow down to give them a reason to use more QE. In other words the grimmer the situation appears the more attractive restarting QE would be.

      So in the event of some combination of the two they may get a majority to go ahead with more QE.

      I would add that I am giving you what I think are their views as personally I do not believe QE has done any real good at all.

  6. Ian_jones says:

    Surely Ben didnt think printing money would actually help the real economy? This was tested to destruction in the 70’s which is why rational expectations theory began. The only way printing money will help is to raise inflation so debts in real terms become lower and hence payable. The price of excess debt is paid by the creditors and the poor. More QE can be the only policy which is why gold keeps rising.

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