Cirque du Ben

The Cirque du Ben will soon be leaving town for good. Some have cheered while others have watched in horror waiting for the disaster, but all were treated to a high wire act unlike any other Fed chairman has ever performed. Fed chairmen are often defined by the consequences of the previous performer. Bernanke had a couple of tough acts to follow in Volcker and Greenspan. Volcker had to guide an economy out of stagflation while Greenspan presided over 9/11, two recessions, and a full market crash in 1987. By the end of his his show, Greenspan had an oversized influence on policy. Bernanke was an unlikely character to follow up a headliner like Greenspan.

He grew up bagging groceries in South Carolina and humble to the point of not wanting to apply to Harvard. When accepted, he thought it was a prank. This quiet, unassuming Princeton economics professor is not the character you would expect to follow the cult of personality that was Greenspan. Often circumstances dictate what is needed, and a student of the Great Depression was needed more than anyone guessed at the time. Like all great circus acts, his demanded dexterity, imagination, and daring.

Let’s Juggle Chainsaws

The job of Fed chair is a juggling act in the best of times. You have to balance conflicting priorities: be above politics yet constantly operate within it, spur growth and employment while controlling inflation, let people know your thinking, but don’t alarm anyone. He started his act juggling balls and clubs in 2006, but in 2008 the financial collapse tossed a couple chain saws into the mix. At Galway we have some experience with juggling chainsaws - literally not metaphorically - and we can tell you that the measure of success is bit more forgiving. It doesn’t have to be perfect. You can lose a finger or two (it just adds to the entertainment value) as long as you do not inflict a fatal wound. If he can keep those chain saws in the air and moving to the end of the act you congratulate him with a big high five (or four or three). Some in the audience may quibble or shriek in horror, but we call it a good show.

Ben’s act started poorly as he underestimated the subprime problem and the consequence of previous policy. Traditional tools of monetary policy would be insufficient for his challenges. Despite losing a few fingers early he sharpened his juggling skills and leaned heavily on imagination to create new and daring policy to address the unimaginable difficulties of insolvent banking and auto industries combined with a paralyzed congress, crashing stock market, and rising unemployment. The Fed chairman not only had to manage the macroeconomic picture but he also had to lead targeted bailouts. Members of congress tried to pull him into a sideshow by grilling him –on more than one occasion – about his Goldman Sachs experience despite the fact that he never worked at Goldman (that was Hank Paulson). He wasn’t perfect. We’ve seen the largest increase in the unemployment rate since the Great Depression and he has inflated the Fed’s balance sheet to unimaginable levels, but he did make sure that we didn’t repeat 1937, when Fed policy errors accelerated depressionary forces. If he were juggling bowling pins such scars would be a failure, but the standard for chainsaws allows for some blood.

I’m Afraid It May Be Bipedal

A Fed chairman’s legacy is often determined by how well his follow up act manages the consequences of his policies. Bernanke’s legacy will be determined by the skill shown by his successor as the Fed reduces its purchases of bonds and unwinds its balance sheet. The policy was unprecedented and so too will be its reversal. Quantitative easing did aid in fighting deflation but without additional policy focused on the velocity of money it failed to stimulate above trend economic growth. The economy has successfully risen off the ground and has started shuffling on its hind legs like a bear in a fez, but now we are afraid to inform bond holders that it has become bipedal.

With the economy now up on its feet, participants are trying to formulate expectations on what the reversal of quantitative easing will look like. Will the mere reduction in Fed purchases be a trigger for a fat tail event or will it be much to do about nothing until the Fed seeks to reduce the actual size of the balance sheet? As we wrote last month ( I Thought the Safety Was On), the 30-year trend of lower rates is a tailwind that is unlikely to be your context going forward. Bill Gross recently said “it’s going to be a war with many casualties” and we would agree. Regardless of outcome, investors who do not adapt to a new context will be casualties. A staggering upright bear is not a death sentence for the market but it does introduce new challenges and opportunities. Will the bear break out and maul the audience or will it ride a unicycle around the ring? The next performer on the stage is in charge of that reverse twist in Fed policy, and that act will define much of Bernanke’s legacy.

Dogmatic Flex

What do we learn from Ben Bernanke’s term as Fed chairman? Market participants that rigidly cling to past experiences to formulate future decisions or embed themselves with a forgone economic conclusion will be doomed. Unprecedented things happen every day. The simple truth is the future context is new territory and the only dogma that will serve investors well in such unchartered jungles will be flexibility. Regardless of which path is followed, new possibilities and pitfalls will be created including ones that can’t even be imagined today. The ability to adapt is essential. Bernanke’s reaction to what he failed to see in 2007 was flexible, creative, and daring. He invented new solutions to new problems. A dogmatic flex will not guarantee success, but it will give you your best chances of making it to a curtain call.

Some will take the view that Bernanke did what he had to. Others will damn his actions as reckless and damaging. As with most great performances the answer is likely to be that both are true. Bernanke’s legacy will be determined largely by how his successor deals with the consequences of his policies much in the same way Ben had to deal with with the aftermath of Greenspan.

As always, we are proud to be your partners and chainsaw dealer while exercising stewardship without compromise.

Best Regards,

The Team

Galway Investment Strategy

[email protected]

© Galway Investment Strategy

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