How to Profit From Ben Bernanke & a Volatile Federal Reserve
by Mark Skousen, Chairman, Investment U
Friday, October 28, 2005: Issue #481
President Bush has nominated Ben Bernanke, his chief economic advisor, to replace Alan Greenspan. Bernanke has the credentials to be a good Fed chairman, and the market spoke favorably of him on the day of his appointment. (More on Bernanke below.)
Wall Street has given high marks to Alan Greenspan as a “maestro” in the all-important world of money and banking. Under his leadership, he has guided the U.S. economy through two bear markets (1987 and 2000-03) that flanked the longest sustained expansion in our history.
But that does not mean that speculative opportunities for profit haven’t existed during his near 20-year reign in Washingtonand we might see more of the same in the Ben Bernanke era.
The fact is that beneath the thin veneer of Alan Greenspan’s monotone voice is a man whose insides have sometimes been eaten up with worry about an Asia currency crisis, a Russian economic collapse, Y2K, and threatening inflation. And he often overreacted to perceived threats, causing opportunities to make a lot of money.
Today, we’ll review the Greenspan era, see just how many times the Fed changed policy during his tenure, and get a take on where we’re headed under Ben Bernanke
Volatility Under Greenspan: Inflation, Recession and Three Panic Attacks
Alan Greenspan’s reign will have lasted from 1987 to 2006. Amazingly, during that period, Fed policy has changed seven times, moving between easy and tight money. That’s a change in monetary policy every two to three years! The chart below demonstrates the volatility of the Greenspan era.
From the crash in 1987 to 1990, Greenspan & Co. raised rates as inflation picked up. Then from 1990 to 1991, they sharply cut rates during the recession. In 1994, Greenspan overreacted to a fear of inflation by raising rates and generating a bear market on Wall Street. The inflation fear never materialized.
Over the following five years, the Fed panicked three times regarding:
- The Asian currency crisis in 1997
- The Russian economic collapse in 1998
- The Y2K computer threat in 1999
In each case, the Fed injected new money into the global economy.
From here, a gradual decline in rates masked the huge increase in liquidity Greenspan had engineered to avert trouble during the late 1990s. As a result, a massive bubble developed in high tech, and the stock market in general. In many ways, Greenspan may have been in part responsible for the “irrational exuberance” on Wall Street, adding some gasoline to the booming fire in tech stocks, to use Steve Forbes’ phrase from my interview with Steve last week.
When the Y2K crisis never developed, Greenspan quickly reversed his position and decided to quickly increase rates and curtail liquidity in 2000. Not surprisingly, the stock market (especially the tech-ladened Nasdaq) collapsed and entered a three-year bear market – the Dow losing up to 40% of its value, the Nasdaq almost 80%.
Alan Greenspan and Ben Bernanke Reverse Course: A 1% Funds Rate and A Stock Market Recovery
Later in 2000, Greenspan embarked on a road of reducing rates all the way down to 1%, far below the “natural rate” of interest. Greenspan said he feared a Japanese-style deflation. It’s worth mentioning that Ben Bernanke was a member of the Fed board during this time, and was a cheerleader for this easy-money policy. Once, when asked if there was anything else the Fed could do to stimulate the economy, Bernanke bluntly replied, “Print dollars!”
But America is no Japan, and the fear of deflation was overblown, even after 9/11. Fortunately, the United States has enjoyed a vigorous recovery since 2003, thanks in part to Greenspan’s efforts.
Meanwhile, the Fed’s artificial low-interest rate policy created all kinds of new profitable ventures. This was especially the case in real estate and on Wall Street, where investors bid up mortgage REITs, and other interest-sensitive investments, to astronomical levels.
Now, the Greenspan Fed has embarked on another campaign to dampen a recent spat of inflation, and they are raising rates every six weeks. As a result, the mortgage REITs, muni bonds, and other interest-sensitive investments have come down.
Conclusions and Bernanke’s Direction
In short, the Fed’s actions can be a huge source of profit for quick-minded investors. I suspect that the new Fed chairman, Ben Bernanke, will offer similar opportunities over the next few years.
Bernanke is a big promoter of “inflation targeting,” a policy adopted by many other countries, including Canada, Australia and the European Union. That could be one reason the stock market is rallying, because low inflation favors traditional stock and bond markets.
But I wouldn’t count out future dramatic changes in policy under Bernanke, similar to the ones we experienced under Greenspan.
Good trading, AEIOU,
Mark
P.S. In my next IU column, I’ll write about how you can profit from the secrets of tax-haven billionaire John Templeton. It pays to live tax-free!
Today’s Investment U Crib Sheet
- Robert Graham is the Toronto radio show host of Canada’s Business Report, and he recently interviewed me on the airwaves. From the stock market to oil and the economy, listen to a recording of the program here. (NOTE: this is an mp3 audio file.)
- The Friedman Effect: Is Another Bear Market Around the Corner?
- Jim Rogers: An Exclusive Interview With The Legendary Investor
- The Fed Fund Rate Announcement & Interest Rate Decision
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