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October 26, 2005

Misreading Bernanke
by T. Stein / S. McIntyre

So it finally happened. On a chilly Monday morning in October, news surfaced that the nomination of Ben Bernanke as new Fed chairman was imminent. Immediately, the stock market rallied as the selection of the Wall Street-friendly Bernanke (who was the odds-on favorite) was seen as a positive development. Likewise, the Dollar dropped slightly and the precious metals edged up as most traders recalled Bernanke as the monetary dove who once declared that the U.S. Government could prevent deflation because the Fed/Treasury can "helicopter" money in to stimulate the economy. Likewise, his musings about "a technology called the printing press" have sent hearts racing in today's momentum driven equity markets and emboldened U.S. Dollar bears to know that however bad Greenspan was, Bernanke is likely to be worse. You see, Greenie followed a central banking legend in Paul Volcker, but at least the economy was fundamentally sound when it was handed over in 1987. In contrast, Helicopter Ben, whether he comprehends it or not, is inheriting a fundamentally flawed economy in early 2006. The mind-numbingly large credit and debt imbalances that have been stoked over Greenspan's 18 years will in all likelihood be unraveled sometime fairly early on in Bernanke's tenure.

According to Briefing.com, the Bernanke announcement "dispelled uncertainty over the Fed Chairman's successor a couple of months earlier than investors had anticipated, and Bernanke's stated intention of maintaining continuity during the transition, as well as a confirmation that Greenspan will remain Fed Head until the official end of his 18 year term in January, seemed to relieve stock investors."

So what are we to make of the market's reaction to the Bernanke announcement? Not much. Actually, we wouldn't be surprised if the investing public is misreading Bernanke. Think about it, a new Fed Chairman's immediate priority is always to establish credibility as a rock-solid central banker willing to maintain political independence. It would be foolish for Bernanke to give into political pressure early in his term by reversing the Fed's direction on interest rates. Yet there has been dissension among the ranks of FOMC members (votes haven't been unanimous lately) and we really don't know what Bernanke will do. Frankly, long-term investors shouldn't loose any sleep over trying to predict interest rates over the short term. Instead, investors should be focused on the consequences of Alan Greenspan "the icon" being replaced by Ben Bernanke "the unknown".

The most important element of our financial system today is confidence. While he lacks charisma, Alan Greenspan is the perfect confidence artist. He is everything an all-powerful central banker should be: boring, elderly, brainy, long-winded, and most importantly LUCKY. Easy Al has been able to paper over all of the U.S.' problems over the last decade or so and to date a drunken U.S. economy has yet to feel the real hangover. There was Mexico in '94, Asian Meltdown/LTCM in '98, Y2K, and the Internet bubble bursting/911 from '00-'02 where Greenspan (frightened at the thought of a normal recession and the accompanying political fallout it might bring) did everything in his power to try and avert the business cycle. Whether it be by lowering the price of money (interest rates) or ramping up the availability of credit through monetary supply increases and the prompting of GSEs and banks to stimulate lending, Alan Greenspan has perpetuated a recession-less economy mentality that will ultimately lead to the mother of all recessions when the giant U.S. real estate bubble he created pops slowing our heavily-levered consumption-driven country and sparking a nasty time in America. Bernanke will be the man in charge of trying to put Humpty Dumpty back together again.

We would guess that 99% of those working in the investment industry never take the time to read through Greenspan's speeches on the Fed's Web Site. Why should they? Substance is not nearly as important as delivery is because body language and tonality make up 93% of communication. As long as Americans can run on their treadmills with boring old Greenspan on CNBC, confidence remains high. Even most members of congress and the media remain utterly clueless about the effects of monetary policy. The ill-winds blowing beneath the surface of the U.S. economy largely go unnoticed. Apart from Bernie Sanders (I-VT) and Ron Paul (R-TX), most congressmen fail to make good use of Greenspan's appearances on Capitol Hill. Republicans and Democrats will either ask elementary school level questions or try to get the chairman to endorse (or reject) a particular policy position.

This will all change once Bernanke takes over. Bernanke, who is younger, speaks a lot less eloquently than Greenspan. Bernanke has been interviewed on CNBC multiple times over the last year, and looks shaky at best. We expect him to struggle mightily when put under the microscope the next time the markets turn lower with vengeance. Never before has the Fed chairmanship changed hands with so many economic headwinds blowing.

Todd Stein & Steven McIntyre
Texas Hedge Report

Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets. For more information, go to http://www.texashedge.com

Copyright © 2004-2008 Todd Stein and Steven McIntyre

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