The Market's Echo Chamber

Jim Cramer—the hyperactive, loud and opinionated host of CNBC's "Mad Money"—is no fan of Federal Reserve chairman Ben Bernanke. If you'd tuned into "Mad Money" any time in recent months, you might have caught one of Cramer's outbursts against the ex-Princeton University economics professor. "Defend us from Uncle Ben Bernanke's relentless march to recession," went one rant. "You know what Bernanke is? He's the General Sherman of monetary policy. He's waging total war against the American economy. Is that Atlanta I smell burning?"

All this is entertaining, but it's also much more. Call it the rise of financial populism. Cramer is its biggest star and, in some ways, it has fundamentally altered the climate in which the Federal Reserve makes economic policy. Throughout its history, the Fed has rarely been popular (the peaceful period in the 1990s under Alan Greenspan was an exception). People often blame the Fed for recessions or high interest rates. But traditionally, politicians, business leaders and unions have been the most vocal critics.

No more. In recent months, the noisiest and nastiest criticism of the Fed has come from Wall Street. Hordes of money managers, analysts, commentators and economists have joined Cramer in ridiculing Bernanke and other Fed officials. They're "clueless" and "behind the curve." The blunt message: cut interest rates more and faster; revive the economy; boost stock prices; save our investments. But these custodians of capital no longer speak only for small numbers of the superwealthy. From 1980 to 2005, the share of U.S. households owning stocks or mutual funds went from less than 19 percent to 50 percent; the number of brokerage accounts rose from 10 million to 109 million.

Just as the late-19th-century populists, mostly farmers, wanted the government to provide cheap money and curb the railroads' power, today's financial populists think government should somehow guarantee that the economy always expands and stock prices always rise. Whenever either seems threatened, there's a clamor for action. Last week, Bernanke's Fed seemed to capitulate. On Tuesday, it cut its overnight Fed funds rate from 4.25 percent to 3.5 percent (as recently as mid-September, it had been 5.25 percent). The Fed's main decision-making body meets again this week; another rate cut is expected, though not guaranteed.

Of course, the Fed doesn't think it was surrendering to critics. Instead, it was trying to avert a financial stampede. Remember the crash of 1987, when stock prices dropped 22.6 percent in a day? Well, with U.S. markets closed last Monday for Martin Luther King's birthday, stocks around the world plunged. Before the Fed took action, global stock markets were already down 12 percent for the year, says Howard Silverblatt of Standard & Poor's; the paper loss totaled $6 trillion. Heading into last Tuesday, signs pointed to a huge sell-off of U.S. stocks. The Fed rate cut aimed to prevent a panic that would feed on itself. Lower rates would improve confidence by cushioning any slowdown.

Fair enough. The trouble is that this may be a distinction without a difference, because market sentiment—what sends prices up or down—is heavily shaped by the financial populists operating through the business cable channels, Internet-distributed commentaries and print press. There is a vast echo chamber in which if something is repeated often enough, it becomes its own reality. When there's mostly cheering, stock or bond prices rise; with boos, prices fall. Either way, the Fed must deal with what "the markets" are saying. The present panicky climate results, at least partly, from all the invective heaped on the Fed.

What Cramer and many talking heads offer are selective and sensationalized views that favor short-term conditions and immediate gratification: higher stock prices tomorrow; better trading profits. By these appraisals, the U.S. economy is in dire shape. Who knows? Maybe a calamity lies just ahead. But as yet, the evidence is unconvincing. For all of 2007, profits of nonfinancial corporations were up 6 percent, says Silverblatt. At the year-end, these companies had a hefty $609 billion in cash or cash equivalents, he notes. They are in a strong position to weather trouble.

Of course, the economy has serious problems. We don't live in an economic utopia and never will. By its nature, a market system involves failures. But every problem—even a recession—is not the apocalypse. In the late 1990s, the electronic echo chamber promoted unrealistic euphoria, which fed the "tech bubble." Now the message has swung to the opposite extreme. It's not just that these portrayals, in both directions, exaggerate. They may harm us by encouraging self-defeating economic policies.

The Fed's first responsibility is to maintain a basic price stability—to keep inflation at low levels—because, without that, its other goals of maximum economic growth and low unemployment become impossible. We learned this lesson painfully in the 1960s and the 1970s. Political pressures then to avoid all recessions led the Fed to relax money and credit too much and too often. As inflation rose, the economy grew increasingly unstable. The perverse results were higher inflation, ultimately reaching double digits, and more frequent and harsher recessions. Annual inflation peaked at 13.3 percent in 1979 and annual unemployment at 9.7 percent in 1982.

Unlike financial populists, the Fed should focus on the economy's performance in the next six years, not the next six months. Some economists think that the Fed is already repeating its previous error, now prodded by "market pressures" and the specter of financial panic. If the market constantly demands to be stimulated by lower interest rates and easier credit, and threatens to go into an uncontrolled tailspin if it isn't, then the Fed is in a treacherous position. What the Fed now does to make matters better may make them worse—possibly much worse—in a few years if it leads to higher inflation. This is a real, if easily overlooked, danger.