There’s an old saw in the investing world: don’t fight the Fed. Just as politicians shouldn’t square off with people who buy ink by the barrel, investors shouldn’t buck the folks who can print endless amounts of dollars. If the Fed says it wants rates to go down, and is prepared to buy bonds to make that happen, the market usually complies.
But not this time. Ever since Federal Reserve chairman Ben Bernanke’s announcement in November that the central bank would purchase $600 billion in government bonds in an effort to lower interest rates, politicians, monetary officials, and investors seem to be spoiling for a fight. German Finance Minister Wolfgang Schäuble dubbed the policy “clueless.” A gaggle of right-wing economists and policy wonks penned an angry letter accusing Bernanke of economic malpractice. The bond markets threw a collective fit, pushing up interest rates in defiance. Some of these attacks are motivated by crass politics. But it’s clear now that the Fed no longer possesses the imperium it had in the 1990s because, too frequently, it has been behind the curve.
In the 1990s then-chairman Alan Greenspan was way ahead of economic trends. His reputation was cemented by a critical insight and gamble: advances in globalization, the advent of China into the world trading system, and the telecommunications revolution meant the U.S. could grow at a higher rate without risking inflation. But that was last century. Since then, the Fed’s record under Greenspan and Bernanke has been one of overshooting, furious rushes to catch up, and frequent displays of bewilderment.
After several months of a jobless recovery, Greenspan took the federal-funds rate down to 1 percent in 2003 and left it there for 13 months, even as the economy was powering ahead. His lethargy in raising rates allowed the housing bubble to inflate. The Fed similarly dozed through the subprime mess. In May 2007 Bernanke said, “We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” In November 2007, when a congressman asked if subprime losses could reach $150 billion, Bernanke responded: “That’s in the ballpark.”
Bernanke, a fan of the woebegone Washington Nationals, must have had a large ballpark in mind. In June 2008, six months after the recession started, the Fed’s Federal Open Market Committee reported the consensus among its members was that the economy would grow between 1 and 1.6 percent for the year. Oops! And despite having responsibility for overseeing the financial sector, and despite employing hundreds of economists, the Fed was continually surprised as one domino fell after another—Fannie Mae, Freddie Mac, AIG, Lehman Brothers, the whole economic system.
The accumulation of behind-the-curve performances has harmed the central bank’s credibility. And the suspicion that the Fed remains in that position explains a good chunk of the market’s current skepticism. Given that the Fed rarely recognizes when the economy is about to shift into a higher gear or go into idle, why should we take its word that its $600 billion purchase of government bonds is all that stands between us and a double dip? And why should we take it on faith when it assures us that its policies won’t ignite inflation?
CBS’s 60 Minutes has long been a refuge for public figures seeking to restore credibility. So you can understand why Bernanke agreed to let Scott Pelley into the temple of monetary policy for the segment that aired Dec. 5. The gambit failed. In the days after Bernanke’s appearance, bond investors headed for the hills. Yields on the 10-year government bonds shot up to levels not seen in months. Sure, the tax deal between President Obama and congressional Republicans (implication: bigger deficits ahead) and perceptions that growth might accelerate played a part. But I can’t escape the feeling that the broad uncertainty about the Fed’s certainty accounted for a big chunk of the action.
Asked what degree of confidence he had in the Fed’s ability to control inflation, Bernanke responded: “One hundred percent.” Wrong answer, Ben! There are some historical dictums everyone should heed: Beware of Greeks bearing gifts. Don’t fight the Fed. And, oh, be cautious of financial titans who profess unvarnished confidence in their ability to manage affairs.
Gross is economics editor at Yahoo Finance.