Monday, December 26, 2005

What's Bernanke going to do during the housing crash?

A Recent NY Times article on the Japanese Housing Bubble
got me thinking. Especially this quote:

Japanese economists say the United States is not likely to suffer a decline that is as severe or long-lasting as Japan's, because they see a more skilled hand at the tiller of the American economy: the Federal Reserve. Japan's central bank, the Bank of Japan, failed to curb the stock and real estate bubbles until mid-1989, when it was too late and prices were sky-high, they said.

Translation: It's different this time! Is it really? Let's listen to some words from Mr Bernanke:

But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Sounds different, but in a really bad way. It won't be like Argentina. Argentina owed external debt in a foreign currency and had a currency peg. I think we will have very serious deflation but Bernanke might take "unconventional measures" and then all bets are off. If only conventional measures are used we'll see the government make a beeline to zero percent interest rates very quickly as soon as the housing bubble starts to affect the economy. Once rates fall below european rates that will start eroding the currency. Europe of course will lower rates too because they can't have an appreciating currency so early in their economic recovery. When rates fall and hit zero thigs will go for a while and the housing bubble, or another internet bubble might come back but if no inflation shows up this time at zero percent, which it might not, then we reach the problem of rates at zero percent. This is the nightmare of central bankers. Bernanke has taken a keen interest in this and has recommended "unconventional measures" like buying things besides treasuries to create liquidity. The central bank will play this where's the money going now game with the investment community. Buying stuff in different markets all over the place confusing investors and the economy to no end.