An Opinion Worth Millions

Whoever thought Ben Bernanke’s golden age was terminated on 1st February, 2014, with the end of his tenure as chairman of the US Federal Reserve, was just plain wrong. The ex-chairman has been on a tight and busy schedule for the past year, travelling from town to town, disseminating his wisdom about financial crises and the future of monetary policy. With the recent financial crisis gone and the Fed supposedly preparing to offload $4 trillion of assets purchased during the last few years, many are those who are willing to pay a few millions for an informed tip about how the Fed will do it, which makes Bernanke a multi-billion dollar asset.

While no longer the head of monetary policy, Bernanke served as chairman of the Fed for eight years, over the course of two mandates, first appointed by the US President George Bush on 1st February, 2006 and then renominated by President Barack Obama on 28th January, 2010. With the financial crisis occurring during his prolonged mandate, Bernanke has certainly more insight than anyone else about the dynamics that led the Fed into lowering interest rates to a near zero level and unfolding three quantitative easing programmes worth more than $3 trillion. At the same time, investors believe that Janet Yellen, the current Fed chairman, has very close ties with Bernanke, which significantly enriches any comment Bernanke makes about the future of monetary policy.

In fact, judging by his busy schedule and the fat fees received, Bernanke’s insights must be worth millions. He his currently one of the world’s highest per word earners, as dining with him to hear his insights on future economic conditions and ask a few questions usually costs the audience north of $200,000. On 4th March, roughly one month after leaving the Fed, Bernanke made his first public appearance at the banking conference in Abu Dhabi, from which he collected as much as $250,000 in speaker’s fees, easily surpassing, in a single day, his annual pay check as chairman of the Fed. With one year of public appearances already under his belt, a quick calculation allows me to guess at total earnings almost in eight figures.

Understanding the Role of Monetary Policy

Before becoming chairman of the Fed, Bernanke was professor of economics at Princeton University, where he dedicated much of his academic tenure studying the Great Depression of 1929 and how both fiscal and monetary policy failed to improve economic conditions at that time. He found that the financial disruptions that followed the crash in 1930-33 reduced the efficacy of monetary policy’s lending channels, thereby allowing aggregate demand to be depressed and turning the recession into a heavy depression. He believes that, even in a mild downturn, banks significantly reduce lending and cut back many of their risky ventures. Therefore, to Bernanke’s mind, at a time when credit expansion is much needed banks simply compound the problem via further aggravating the economic cycle and potentially turning a mild recession into a deep depression. So, as the theory goes, the central bank should act quickly and vigorously to counteract the reduction in lending.

Bernanke believes that if there is a rotten pipe in your house and your wife wants to take a bath, the best way to ensure the water flows to the bathroom is by pumping more water through the pipe. Part of the water would be lost through the leak, but most would eventually arrive in the bathroom and make your wife happy, such is the strength of the flow.

Now, returning to the real world where pipes and water are replaced by banks and money, the problem lies in the fact that banks act pro-cyclically and thus tighten credit conditions during recessions and relax them during expansions, significantly contributing to the boom and bust cycle. The solution then lies in curtailing their active role in money creation and not in dumping one hundred dollar bills at no cost in their vaults in the hope they will lend more. In doing the latter, the Fed just loses control over its actions. Translating this back into the above example, taking a bath would now be possible but at the cost of sinking the house. In the future you would have to repair not only the leaks in the pipe but also the house.

Bernankonomics Doesn’t Need To Look Right

But the reason why someone is paying more for Bernanke’s speech than for my words at this blog has nothing to do with skill. Not that I am saying I have more skill than Bernanke does. Just that it doesn’t matter at all. Investors are not paying a quarter of a million dollars to Bernanke for the soundness of his economic theory. He could develop the most foolish economic policy ideas and investors would still be happy to pay him the same fee as long as they believe Bernanke’s ideas reflect the path to be taken by the Fed.

Many are those who believe Bernanke is still some kind of insider regarding monetary policy and thus are willing to pay a few thousand to get an edge over the market. That is the main reason why Citadel and Pimco have just hired Bernanke as an advisor for their funds. Both are very sensitive to any interest rate change. Any sound clues about the future path of interest rates may give them the alpha they so furiously seek for. Citadel is one of the most levered hedge funds (in a regulatory basis) earning much of its income from high frequency trading. The possibility of getting the advice from someone who can anticipate the Fed’s policy statements (as well as interpreting the language used) is certainly worth a few million per year. Regarding Pimco, with the departure of Bill Gross to Janus Capital, the company has experienced near $100 billion in redemptions. Hiring the Fed’s ex-chairman will reverse the flow, they believe.

It is interesting to notice how fiercely investors believe there is something material they can extract from past insiders. Paul Volcker left the Fed 28 years ago, in 1987, but he can still extract a $40,000 speaker’s fee.

The current monetary policy may not look sound to most of us. The policy rate should eventually be around 2%, as the US economy is recovering and the output gap decreasing. But those aren’t the thoughts of Bernanke, who recently redefined the Taylor rule to accommodate a lower interest rate by using the PCE index instead of the GDP deflator (underestimates inflation), by claiming that the real rate of interest is lower than the 2% used by everyone else, and by doubling the weighting allocated to the output gap. These changes allow negative rates to arrive sooner than they otherwise would and then justify a full set of unconventional measures while allowing for prolonged low rates. So: (1) I may be right when I say the current interest rate should be near 2%; (2) the redefinition of the Taylor rule by Bernanke to fit the current policy rate may taste like data mining. Nevertheless you should follow Bernanke, not me.