Anatomy of a scare


The chairman of the Federal Reserve, Ben Bernanke, said something last week that seemed quite reasonable — and the roof fell in on global markets.

Mr. Bernanke said the economy seemed to be recovering, if slowly, and that if the trend continued, the Fed would pull back on its stimulus efforts — keeping interest rates low and buying bonds the market is not absorbing.

The stock market freaked out at this seemingly mild, and positive, declaration. As economist John Kenneth Galbraith said throughout his career, the market is perverse. It tends to go down when the Fed predicts improvement in the overall economy. Improved economic growth makes it more likely that the Fed will provide less stimulus, precisely as Mr. Bernanke indicated.

So money tightens up, which means speculative investment is more scarce. The market thrives on the movement of money. Less movement, less play, and Wall Street is less happy.

But New York Times (and Blade) columnist and Nobel economics laureate Paul Krugman thinks Mr. Bernanke misspoke. Mr. Krugman writes on his blog that “the Fed has been consistently over-optimistic since the crisis began.” He says the Fed can help “by conveying the message that it will wait to tighten, that it will let the economy recover and allow inflation to rise before hiking rates.”

Mr. Krugman argues the Fed doesn’t understand that this is not a conventional recession, but a permanent structural reduction of jobs. Not only is unemployment high, he says, but good jobs are fewer and not being regenerated.

Hence, the market is always volatile. Ironically, Mr. Krugman infers that the market understands the fragility of the recovery better than the Fed does.

Finally, the voice of conventional wisdom: “While volatility is going to remain high, the market next week will move to a consolidation phase.” Thus says Peter Cardillo, chief market economist at Rockwell Global Capital in New York. That’s Wall Street-speak for: This too shall pass.