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Monday, January 25, 2010

Steve Keen describes the why's of what we all know, Bernanke must go

We at Demand Side were perplexed when Obama put Ben Bernanke back up for Fed Chair.

In December we wrote:
Baffled Ben Bernanke and the entire Fed are marching to the wrong tune in the wrong direction. They mimick nothing so much as blind men in a cluttered alley, crashing into obvious obstacles and lashing out against nonexistent enemies. Here are some questions for the esteemed Fed Chair.
In August we put on the podcast:
"More Bernanke? ..... NO. Bernanke back at the Fed? The question of the day, or one of the questions, is whether to re-up Baffled Ben Bernanke in January for another term as head of the Federal Reserve.

You know our response: Bernanke failed to understand the crisis approaching, allowed the systemic collapse to unfold until at the last moment he rushed in with trillions in central bank funds for the big banks, and now clings to the tatters of his legitimacy with the plaint, "At least we avoided the Great Depression."

It's a defense that is far less justified but far more accepted than the similar one from the Obama Administration. In spite of the clear positive effects of the Recovery Act (see ChristinaRomer's defense to the National Press Club posted on the blog), Obama is not getting much traction with "It could have been worse."...
And right at the time, we were confounded as was nobody else:
What a disaster. Ben Bernanke to be reappointed Fed Chairman: This reveals very deep problems in the Obama program.

Bernanke was chief economist to George W. Bush, from which position he rose to Fed chairman. It is often remarked that we are so lucky to have an expert on the Great Depression in charge when the second Great Depression came knocking.

Bernanke was put in charge not because he is an expert on the Great Depression, but because he values the big banks above all else. He is deep in the pockets of Wall Street. His theory of the Depression is that it could have been avoided if we'd just saved the institutions that caused it. Witness the hundreds of billions of dollars in transfer from the taxpayer to the big banks, the free too-big-to-fail insurance, the many missed calls and predictions, the absence to this day of real help for mortgage holders when their main asset goes down.

Here is Keen, complete and clear.
The economic case against Bernanke
Steve Keen
Debtwatch No. 42
January 24, 2010

The US Senate should not reappoint Ben Bernanke. As Obama’s reaction to the loss of Ted Kennedy’s seat showed, real change in policy only occurs after political scalps have been taken. An economic scalp of this scale might finally shake America from the unsustainable path that reckless and feckless Federal Reserve behavior set it on over 20 years ago.

Some may think this would be an unfair outcome for Bernanke. It is not. There are solid economic reasons why Bernanke should pay the ultimate political price.

Haste is necessary, since Senator Reid’s proposal to hold a cloture vote could result in a decision as early as this Wednesday, and with only 51 votes being needed for his reappointment rather than 60 as at present. This document will therefore consider only the most fundamental reason not to reappoint him, and leave additional reasons for a later update.

Misunderstanding the Great Depression

Bernanke is popularly portrayed as an expert on the Great Depression—the person whose intimate knowledge of what went wrong in the 1930s saved us from a similar fate in 2009.

In fact, his ignorance of the factors that really caused the Great Depression is a major reason why the Global Financial Crisis occurred in the first place.

The best contemporary explanation of the Great Depression was given by the US economist Irving Fisher in his 1933 paper “The Debt-Deflation Theory of Great Depressions”. Fisher had previously been a cheerleader for the Stock Market bubble of the 1930s, and he is unfortunately famous for the prediction, right in the middle of the 1929 Crash, that it was merely a blip that would soon pass:

“ Stock prices have reached what looks like a permanently high plateau. I do not feel that there will soon, if ever, be a fifty or sixty point break below present levels, such as Mr. Babson has predicted. I expect to see the stock market a good deal higher than it is today within a few months.” (Irving Fisher, New York Times, October 15 1929)

When events proved this prediction to be spectacularly wrong, Fisher to his credit tried to find an explanaton. The analysis he developed completely inverted the economic model on which he had previously relied.

His pre-Great Depression model treated  finance as just like any other market, with supply and demand setting an equilibrium price. In building his models, he made two assumptions to handle the fact that, unlike the market for, say, apples, transactions in finance markets involved receiving something now (a loan) in return for payments made in the future. Fisher assumed

(A) The market must be cleared—and cleared with respect to every interval of time.

(B) The debts must be paid.”  (Fisher 1930, The Theory of Interest, p. 495)[1]

I don’t need to point out how absurd those assumptions are, and how wrong they proved to be when the Great Depression hit—Fisher himself was one of the many whose fortunes were wiped out by margin calls they were unable to meet.  After this experience, he realized that his equilibrium assumption blinded him to the forces that led to the Great Depression.
and there's much more at Keen's Debtwatch site.

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