Weekend Contemplation #2 – Ben Bernanke – Expert on the Great Depression

For those of you that may not be aware, most of Ben Bernanke’s academic career was spent studying and understanding the Great Depression (see Amazon.com). I was aware of this about the time of his appointment so I always wondered if this is one of the reasons he was selected to head of the Fed. Text in bold is my emphasis. From the UK Telegraph:

The co-ordinated move by five central banks to shore up confidence in the world’s frozen money markets is not the first piece of international co-operation to fend off a financial crisis.

There have been several combined efforts in the currency markets, such as the 1985 Plaza accord when five governments agreed to push the dollar lower to reduce America’s current account deficit and lift the world’s largest economy out of the recession of the early 1980s.

It is, however, one of the biggest joint efforts so far, and the first major intervention of its kind since the September 11 terrorist attacks in 2001. The simultaneous initiative was designed to have maximum impact, to be greater than its parts, which are in fact quite different local initiatives.

The scale of the cash injections – up to $24bn (£11.7bn) in Europe and up to $80bn in the US – is not huge in the context of the hundreds of billions of dollars that have evaporated since the sub-prime crisis broke in the summer, but the presentation of a united front by central bankers on both sides of the Atlantic has symbolic importance.

Although there are no real historical precedents for this type of joint action, the need for central banks to pull together has its genesis in the financial crises that punctuated the last century.

It is no coincidence the collaborative effort should have been co-ordinated by Fed chairman Ben Bernanke, who has devoted much of his professional life to a study of the causes of the Great Depression. No head of the Federal Reserve has had such a keen sense of history.

The lesson from the Depression for Bernanke is that the falling value of assets such as housing and a weakened banking sector pose a significant threat to the economy. Between 1929 and 1933, US economic output fell by 30pc, unemployment rose to 25pc and thousands of banks failed. Prices fell 10pc a year as America slipped into a deflationary spiral.

Aware of the terrible toll of the Depression, Bernanke has always been open to creative and original responses to financial crises. Sometimes this has opened him up to criticism – for example, in 2002 when he said the Fed could always print money to fight deflation. He once wrote that President Franklin Roosevelt’s biggest contribution to ending the Depression was “his willingness to be aggressive and to experiment”.

In 1998, Federal Reserve chairman Alan Greenspan intervened to organise a rescue of Long Term Capital Management, a hedge fund set up by nobel prize-winning economists that blew up in the face of that year’s Asian financial crisis.

Three years later, central banks on both sides of the Atlantic agreed similar currency swap lines to yesterday’s to prevent a seizure of the system in the wake of the terrorist attacks in New York and Washington.

The jury is out on whether this intervention will be successful. Julian Jessop, chief international economist at Capital Economics, concludes: “Risk premia are likely to remain permanently higher after the excesses of the last few years. The world economy is still facing a marked US-led slowdown in 2008.”