We Still Haven’t Learned The Right Lessons From The 2008 Crash

Monday, September 17, 2018
By Paul Martin

by Brendan Brown via The Mises Institute,
Mon, 09/17/2018

Financial media-administered history lessons – whether by commentaries or interviews – on the Great Crash that occurred 10 years ago are frightening. The would-be history teachers are in total denial (or ignorance) of the key fact that 2008 was a monetary-made disaster. This climate of denial continues to foster ever greater danger in the future not to mention a heavy cumulative burden in the decade since – as measured by prosperity lost.

In effect, the Central Bankers Club and their backers among the political elites have been totally successful, it seems, in expunging monetary forces as the key driver – or even as a major factor – in the journey to the 2008 Crash. This started with President George W. Bush nominating Ben Bernanke as a Fed Governor (effective August 2002) in the clear expectation that this Princeton Professor would prove effective in implementing the monetary inflation which he preached. True, Alan Greenspan was still the chief, but by then on shaky footing, given the known hostility of the Bush-Baker “clan” which resented his earlier close cooperation with the Clinton Administration. And Before that, Greenspan was perceived to have some responsibility for the 1991-2 economic downturn which spelled defeat for the older Bush. The implicit term extension deal for Greenspan in 2003 (by two years) was that he would “listen” to the new Governor from Princeton.

George W. Bush’s expectations were met when the Greenspan/Bernanke Fed in early 2003 decided on the novel policy of “breathing in inflation” from what it perceived as too low a level. The Princeton Professor was a zealot of the 2-percent inflation standard and had no truck with concerns that the rhythm of prices was now downwards for some time due to the nature of technological change and globalization. The result; monetary inflation in the asset markets (credit, real estate, in particular) developed in a virulent form (including its well-known aspect of rampant financial engineering).

The European and Japanese central banks, confronted with a weak dollar, initiated their own policies of monetary inflation. There was the notorious adoption of a 2-percent floor (the same height as the ceiling) to inflation by the ECB. This was announced with much fanfare by Professor Otmar Issing (the ex-Bundesbanker eminence grise) in Spring 2003. Meanwhile, the BoJ was running the first modern experiment in quantitative easing.

Then in the two years following early autumn 2004, the Federal Reserve (Bernanke became Chair in February 2006) relentlessly raised the Fed funds rate in mini equal steps by 425bp (from 1% to 5.25%). No question that was a sharp tightening of monetary policy, and unsurprisingly in 2006, there was much commentary about an evolving housing downturn and economic slowdown. But the Fed did not budge given that CPI inflation in the middle months of 2006 briefly spurted to just above 4% year-on-year before receding suddenly and sharply back towards target.

We learn from Milton Friedman that monetary policy operates with a long and variable lag. And by Spring 2007 the signs of credit market pull-back were multiplying; then a first crisis of illiquidity erupted in Europe and in the US during Summer 2007, evident in both the banking system and the wider shadow banking system. Even then the Bernanke Fed would hardly ease policy, relying instead on a multiplication of special liquidity measures to keep the banking system afloat.

The NBER now dates the US recession as starting in the fourth quarter of 2007. But at end of that year, the Fed funds rate was down barely 100bp from its earlier peak. The Fed continued with small and steady cuts of official rates through the first few months of 2008. This most likely meant that overall monetary conditions tightened, given the contemporaneous business cycle slowdown and credit market pull-back. Indeed, during late Spring and early Summer (2008) the Fed signaled that rates could increase in response to the “inflationary effect” of the oil market bubble at that time. And even in the autumn of 2008 in the midst of financial panic, when the Bernanke Fed at last allowed short-term rates to collapse, it prevented them reaching zero by starting to pay interest on reserves.

The Rest…HERE

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