Which Bernanke? Whose Bubble?

Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve.  But which Bernanke are we getting?  There are at least three.

1. The Bernanke who led the charge to rescue the US (and world’s) financial system after the Lehman-AIG collapse.  If you accept that the choice from late September was “Collapse or Rescue,” this Bernanke did a great job.
2. The Bernanke who argued for keeping interest rates low as the housing bubble developed.  This Bernanke was part of the Greenspan Illusion – the Fed should ignore bubbles and “just clean up afterwards.”  Is that still Bernanke’s view?  Surely, he has learned from that experience.
3. Then there is Bernanke-the-reformer.  Given #1 and #2 above, shouldn’t he be pushing hard for tough re-regulation of the financial system – particularly those dodgy parts where markets meet banking?  But is there any sign of such an agenda, even with regard to recently trampled consumers – let alone “too big to fail” financial institutions?

Most likely, we’re in for another bubble.

The Fed will keep interest rates low for the foreseeable future.  This will make sense given continued high rates of unemployment in the US economy.  But unemployment indicates average economic outcomes – high unemployment is completely consistent with some parts of the financial sector expanding at record rates: this is part of the two-track story.

The big banks have access to large amounts of Fed-provided funding at very low rates.  We’ll see this reflected in speculative market activities (think oil).

We’ll also see this in global capital flows (i.e., gross flows, perhaps also net flows – but the new global imbalances may not be so obvious in the pattern of current account surpluses/deficits around the world).  The US is increasingly a cheap funding environment, if you are a big player (definition: anyone regarded as an important client by Goldman).  Rates now begin to rise in emerging markets, as their economies turn around.  The Asia story will be compelling fundamentals and a great carry trade (borrow cheaply in dollars, lend at higher rates in Asian currencies) – and the exchange rate risk is for appreciation against the dollar.

Everyone involved knows this is unsustainable, but also that it can last for a while – and they can get out before everyone else.  Or, alternatively, that – as major financial players – they can’t afford to sit on the sidelines (talk to Chuck Prince: what has changed, in ideology, policies, and people at the top since his day?).

Presumably, commodity prices also get dragged up – or perhaps they jump up in anticipation of the Coming Asian Boom?  Now this might lead Asian central banks to tighten, but probably not if these economies can continue to keep wage costs under control.  And it might lead the Fed to tighten, but probably not as the mantra of focusing on “core inflation” (without food and energy prices) remains intact – however anachronistic it may seem to the rest of us.  It’s hard to see Bernanke #2 doing anything different, except perhaps at inconsequential margins.

So then we really bubble – and perhaps we even mistake it for a boom.

When the Big Crash comes, there’ll be another moment of decision: “Collapse or Rescue.”  And we know what Bernanke #1 will do.  Which is, of course, why this administration is reappointing him – and not seriously re-regulating big finance.

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