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There will be blood...

Written By Brian Hicks

Posted February 28, 2008

To address dampened consumer confidence, Congress is passing legislation to mail 300 million copies of “Don’t Worry – Be Happy” to all Americans.  It’ll be mailed with a Bernanke smiley-face and will be deducted from your tax rebate checks.  Oh, and don’t worry, the Fed is here to help.

I just find it interesting that 10 months after Bernanke uttered:

“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…” 

…we now found ourselves looking at possible bank failures, the weakest dollar in history, recession, stagflation, $950 gold, $102 oil, higher unemployment, and homeowners losing homes by the truckload.

But, hey, don’t worry about it.  Everything’s fine.  That is, if you believe Bernanke’s Congressional testimony.

Though, I prefer the more honest testimony the Fed should’ve introduced.  According to The Big Picture, it would’ve gone something like this:

“Opening statement of the FOMC Chair, Senate Testimony
February 27, 2008:

Senators, we find ourselves in a very challenging situation. 

Following the dot com implosion, my predecessor at the Fed slashed rates to a generational low of 1%; the FOMC then kept rates at 1% for over a year.

While that re-inflated the economy, it also set off a shock wave of inflation unseen since the 1970s. Houses doubled in price, Oil is up 5 fold, food stuffs have tripled, and the dollar has collapsed. Gold is at multi-decade highs.

As always happens, these price increases in hard assets attracted speculators, and that made the situation — especially in housing — much more complex. Even worse, the housing speculation contributed to a debacle, while  these other assets are actually accelerating in price.

Further, as was the political fashion, deregulation and a lack of interest in the oversight role of the banking system allowed an unprecedented expansion of credit, including to the least credit worthy consumers. Additionally, derivative selling — at is heart, an unregulated form of insurance — expanded from a few billion dollars to $46 trillion dollars.

The credit crunch is unprecedented, far worse than the S&L collapse and Long Term Capital Management  — combined.

All of these factors have combined to create our present situation. Inflation remains very elevated and worse, quite sticky. Growth continues to slide towards zero — and possibly beyond.

Like many others, our forecasts in these areas have been wrong. We expected the slowing economy to moderate inflation, and so far, that has not happened. Demand for commodities from China and India is keeping prices elevated. The weakening dollar — now at levels last seen in the 1960s — is forcing all dollar denominated commodities higher. I don’t necessarily believe in “Peak Oil,” but the fact that the Saudis are one of the world’s biggest investors in alternative energy research might tell you something.

The last time a slowing economy failed to moderate prices was the 1970s. Even as the economy slid into recession, we had major spikes in the prices of energy, food, clothing.

What is particularly worrisome to me is that as we have slashed interest rates 225 basis points, consumer loans — mortgages and revolving credit — have actually moved higher.

Gentleman, this is a major problem. And our internal, non-public projections forecast it is only going to get worse for the next 4 quarters…”