On February 2nd, I had dinner with former Fed Chair Ben Bernanke. I hasten to add, lest I give you the wrong impression, that the occasion was the CFA Society Boston Market Dinner, and there were approximately 1,100 guests in all. Bernanke’s remarks highlighted the event, followed by Society President George Hoguet’s extended Question and Answer session with Bernanke.
Bernanke’s remarks focused on the current economic situation. He was largely optimistic. He took a long view, emphasizing the US economy’s progress since the Great Recession. Economic activity has fully recovered and is now 12% higher than the pre-recession peak. Europe has not fared nearly as well. Its economic activity has just now fully recovered.
Furthermore, even though the recovery is now eight years old (dating from the trough in 2009), there is no reason to think that recession is more likely than normal. Consumers have reduced their debt levels, and consumers are wealthier. Consumer confidence is up (even more since the election). The Federal Reserve is likely to increase interest rates as the economic situation continues its return to normal.
However, there is a major concern. There is a significant imbalance between those Americans who have benefited from the recovery and those who haven’t. Bernanke identified three major issues. One, the financial crisis was catastrophic for many. He observed that there was substantial political upheaval after the Great Depression also. Two, globalization has had an uneven impact, with substantial benefits for many and significant losses for many others. Three, even though the economy has recovered, productivity growth has been slow. Faster productivity growth would be required for most Americans to enjoy an improvement in their living standards.
Bernanke is less optimistic about redressing the imbalances. Any solution would have to address inequality and slow productivity growth. Productivity measures increases in output that can’t be explained by increases in worker hours or capital invested. There are no simple policy prescriptions to reduce either inequality or to increase productivity.
Furthermore, Bernanke does not believe that the new president’s policy program tax cuts, increased infrastructure spending and deregulation are likely to address either inequality or productivity.
He had a very interesting perspective on recent stock market gains, which he attributed to investors’ anticipation of benefits from unified government. Bernanke suggested that this unity was more apparent than real. We have already seen that traditional Republicans don’t see eye to eye with the new president. In the Congress, many Republicans are “deficit hawks” who want to see all new spending paid for with an increase in revenues. While Democrats may be willing to support infrastructure spending not funded by tax increases, the deficit hawks are unlikely to go along. Similarly, while President Trump was elected on a platform of renegotiating trade deals, there is a large “free trader” block among Congressional Republicans.
In addition, Bernanke pointed out that trade is much more complicated than the new president’s communications suggest. The supply chain is very highly integrated. Bernanke told an interesting story about the economic impact of the 2011 tsunami in Japan. Initially, the Federal Reserve economists he consulted thought that the impact on the US auto industry would be small. There was relatively little direct input of Japanese parts into American cars. After further research, however, the economists learned that there were substantial Japanese contributions to US parts – subassemblies, small components, etc. So, when we talk about Japanese imports in the auto industry, we’re not talking about cars, or parts, but “sub-parts.” As a result, trade restrictions and tariffs are likely to lead to unexpected problems.
Finally, Bernanke suggested that if investors believe that tax cuts and increased infrastructure spending will increase the deficit, they will anticipate inflation. Interest rates will rise and the dollar will strengthen (that is, a dollar will buy more Euros, pounds and yen). This will make the deficit more expensive to finance, making the president’s program even less popular with the deficit hawks. It will also make imports less expensive and exports more expensive, which won’t help with job growth, including manufacturing job growth.
The question and answer session largely covered technical issues of little general interest (the audience of investment professionals was rapt, however).
I think several comments are worth sharing:
- Bernanke observed that productivity growth has been slower than the most pessimistic experts have forecast. He believes that it may improve simply as reversion to the mean – that is, it should catch up to the forecasts. In addition, there are enormous technological changes ongoing. Productivity may improve as the economy digests them.
- He is optimistic that the financial system may be more stable as a result of Dodd-Frank. In particular, he believes that the orderly liquidation structure (including “living wills” for complex financial institutions) represents an improvement over the ad hoc approach the Fed and the Treasury had to take during the Financial Crisis. In addition, the banking system is better capitalized and thus more resilient. He did say that if the changes to Dodd-Frank removed the orderly liquidation structure without restoring ad hoc resolution authority to the Fed and the Treasury, it would be a significant step backward.
- Bernanke suggested that the changes have made it less clear that the government will bail out large financial institutions if they become insolvent – Moody’s has downgraded bank credit based on this change.
- He argued that Quantitative Easing (the Federal Reserve’s purchase of large amounts of bonds) has been a fiscal success. From the interest on the bonds it now owns, the Federal Reserve has been contributing about $100B per year to the Treasury, or $.5T in total toward reducing the deficit.
- Bernanke is not a fan of reducing trade. He argued that it could damage international relations and the productivity of the US economy through the disruption of US supply chains. It is true that US consumers have shared the benefits of trade and globalization unevenly, but it will be very difficult to reverse globalization.
Former Chair Bernanke’s comments reminded me that even though the government cannot directly produce the outcomes its citizens would like, it can facilitate economic activity by setting clear rules and limiting bad and disruptive behavior. We are in a much better place economically than we were eight or nine years ago, and much of the credit must go to the actions of the Federal Reserve.