Why Former US Federal Chairman Ben Bernanke Is Wrong About Monetary Easing…and Australia’s Asset Bubbles

The former chairman of the US Federal Reserve, Ben Bernanke, believes rising asset bubbles don’t present a risk to Australia’s economy. That’s why he suggests the RBA should lower rates further if the economy needs a stimulus. And he doesn’t think this poses a problem for assets like stocks or properties.

There’s a lot to take in here. But let’s start with the obvious one. Mr Bernanke is wrong about asset bubbles. The record growth in assets like housing is perhaps the largest concern facing the economy. Why? Because they indicate that the RBA’s fiscal policy isn’t working.

The RBA’s recent interest rate cuts were meant to lift business and consumer spending. That hasn’t materialised. At the same time, the property market continues to rise. So rate cuts are having an effect, but only investors are feeling — and benefitting — from it.

Since the GFC in 2008, we’ve seen nothing but rising asset prices. The ASX 200 index has added 2000 points since then. National house prices grew by 7% in the past year alone, to say nothing of their growth since 2008.

But Mr Bernanke doesn’t see any parallels to prior asset bubble cycles. For instance, he doesn’t believe the stock market bears any resemblance to the tech bubble of the 1990s.

Let’s assume that he’s right for a moment, and that the stock market is in no danger of imploding. Does that make it more acceptable for the RBA to continue cutting rates? I don’t believe it does.

Lowering interest rates should serve the purpose of increasing spending across the entire economy. But this credit expansion largely has the effect of funnelling money into assets. In an era of easy credit, interest rates are pushing up assets rather than the economy as a whole.

So how exactly does Mr Bernanke suggest we get around this problem? More rate cuts. You can see the emerging trend here. Rate cuts are the only answer for an ailing economy…but they answer nothing at all. His reasoning is that asset bubbles are currently under control. That makes it fine to keep lowering rates to keep the economy afloat. It’s a flawed logic, as it doesn’t address how to increase spending in the real economy without piling on more debt.

Monetary easing was a viable policy when we could rely on China’s demand for steel to bail us out. That’s now nosedived, leaving the budget deficit at $35 billion for 2015–16. On top of that, government debt has ballooned out to $400 billion. Mr Bernanke’s advice is to borrow more and add to the growing national debt pile.

But Mr Bernanke is right in one respect. The RBA will continue to drive down the interest rate to stimulate the economy. They are as toothless as their US counterpart. It’s the easy solution to a problem that has no answer — at least not one ending in complete economic disaster.

So that’s the future we have to look forward to: lower rates, rising debt, and growing asset bubbles. As this debt continues to grow, it makes the inevitable crash, when it happens, all the scarier.

Monetary easing is not the long term solution to economic prosperity

There’s a good reason why monetary easing doesn’t work. It’s a stop gap measure, the equivalent of kicking the can down the road. Adding more money into the system out of thin air doesn’t make the economy more prosperous. It just adds more money into the system — money that accumulates as debt to be repaid at some point.

Mr Bernanke knows all about the relationship between monetary easing and debt. It was under his stewardship that credit expansion in the US really took off. The Fed is responsible for injecting US$4.5 trillion worth of stimulus (debt) since 2008. The US currently has $17 trillion worth of debt.

Yet Mr Bernanke actually believes his policies have been effective. Here’s what he had to say:

At least so far, [monetary easing programs] haven’t had many of the bad side-effects that people were saying were bound to come’.

That may be so for now. But the point is that they will. He’s not stupid enough to believe that asset bubbles can keep inflating away forever.

Economic cycles move in trends. Things rise…before they collapse. In Australia’s case, the rise of property prices in key markets has been astronomical. Sydney’s real estate has grown by 40% in the past three years. That’s great for investors, but it’s not healthy for the economy. Why is that?

For one, banks now have massive exposure to the housing market. That’s a major problem if the economy takes a turn for the worse. This relationship between banks and borrowers could spell disaster for the economy. Let me give you an example for how this could play out.

Yesterday, the ABS released figures showing that business spending is projected to drop by $40 billion in the next financial year. That means the 6.2% unemployment rate isn’t likely to come down. Instead, it points to an ever increasing unemployment rate.

That in turn could force home loan borrowers to default on loans. If that spawned into mass foreclosures, then banks would be at high risk of getting brought down alongside them.

At best, it would force banks to curb their lending. That in turn would affect every sector of the economy, as borrowing rates would skyrocket. It would spiral out of control very quickly, the same way it did in 2008.

Australia only survived relatively unscathed in 2008 because the mining boom was in full swing. Without that added support, the next crash could be catastrophic.

That’s why it’s easy to look at things now and say they’re fine. But at some point, the weight of those growing assets (and the debt that supports it) will collapse in on itself. The problem for us is that we’ll have nothing to fall back on once things take a turn for the worse.

Why Australia isn’t prepared for an economic downturn…and what it means for stocks

As Markets and Money’s editor Greg Canavan explains, the financial system isn’t equipped to deal with the next downturn in the business cycle:

Seven years into an expansion, we’re not far off experiencing that downturn. Interest rates across the world are close to zero [Australia’s is at 2%]’.

And they’ll drop much further as the RBA scrambles to keep the economy above water. All the while, our debt levels continue to rise. There simply isn’t the scope for any kind of fiscal stimulus. Greg continues:

That’s why higher interest rates are not possible in this environment. Central banks are trapped. Everyone knows it. Which is why global stock markets around the world remain near record highs. They are discounting continued central bank involvement and easy money forever.

Australia can’t even rely on stocks to mask the growing economic concerns. The ASX 200 is valued below its pre-GFC highs, hitting a walling at the 6,000 mark.

The problem with Aussie stocks is their lack of diversity. The financial sector makes up 44.2% of the ASX 200 index. That’s compared to 14.4% for materials and 7.6% for industrials. Why is that a concern?

It’s because materials and industrials are productive sectors. They sell and produce tangible goods of real value. Financials on the other hand don’t. Financials only take advantage of the money that’s already in the system. Greg explains:

The ‘materials’ sector generates the income (think iron ore exports) while the financial sector leverages this income up (with the help of the RBA when it lowers interest rates) to produce speculative asset price gains (think stocks)’.

As we’ve seen, the RBA has nothing left but to continue pushing down rates to prop up the economy. Despite Mr Bernanke suggesting otherwise, there is no evidence that proves monetary easing does anything beneficial for an economy. It makes some people richer for a while, but only sets us up for a major crash once the RBA can’t lower rates any further.

Mat Spasic,

Contributor, Markets and Money

PS: Greg is one of Australia’s leading investment analysts. He’s written for the The Australian and Sydney Morning Herald…and he’s regularly appeared on CNBC and Sky Business.

He doesn’t believe the RBA’s monetary easing will be enough to arrest the economy’s decline. In fact, he’s convinced that Australia faces a recession in 2015.

In a free report, ‘Australian Recession 2015: Unavoidable’ Greg reveals why we’re set for a sustained period of economic decline. He’ll show you why our debt levels are so out of control, and why that means a recession is inevitable. And he’ll prove to you why the RBA know the recession is coming. Download your copy today and Greg will show you what you can do to protect your wealth from the fallout of the recession. To find out how to download his free report right now, click here.


Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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