Weekend at Bernanke's

We all remember the late-1980s classic moronic comedy Weekend at Bernie's. And we'd all like to forget Weekend at Bernie's II. These are important movies, however, in understanding the current financial crisis.

As a quick refresher, here's IMDB's synopsis of Weekend at Bernie's:

Richard and Larry are two best friends who discover that someone has been embezzling money from their company. When they inform their boss, Bernie Lomax, he is so apparently pleased that he invites then to his beach house for a weekend of fun and leisure and women. But once they arrive, they discover him dead! Richard wants to do the right thing and inform the authorities as quickly as possible, but Larry is determined to still try and have a weekend of fun and leisure and women.

After the tech bubble popped, and 9/11 happened, the economy, like Bernie, was dead. The problem is, we're a nation of Larrys. We have a hard time when people try to make us stop the party. So the Federal Reserve, in an effort to keep the party going, propped up the American economy with low interest rates.

Part of the fun and ridiculousness of Weekend at Bernie's was the fact that it seemed fairly obvious to us, the viewer, that Bernie was dead, but somehow the dumb guests had no idea, and never caught on to the fact that Bernie wasn't seen for the entire weekend without the help of Richard and Larry. Hauling around a dead guy is bound to lead to some longer-term pain (such as a potential jail sentence) than the pain of not partying, but Richard and Larry wanted to keep the party going. In their minds, maybe the partying could continue and they could somehow get away with the fact that they hauled a dead guy around a Hamptons beach house for an entire weekend without alerting the police.

Similarly, the Fed probably knew that lowering interest rates would cause some serious long-term pain, but they didn't want the party to stop. In fact, for a time, the Fed convinced itself that it could do both -- it could have extremely low interest rates without causing inflation.

In other words, like Bernie, the economy was being artificially propped up. But, low and behold, there were consequences for Larry and Richard, just like there were consequences for the economy. Eventually, the economy hit the skids again in 2008, and in Weekend at Bernie's II, we find out that Larry and Richard are fired. But once again, like good Americans, and like the Federal Reserve, they don't go softly into the night. No, they need to revive Bernie once more:

In the first film, Larry and Richard were forced to create the illusion that Bernie was still alive in order to avoid being killed themselves. In the sequel, Larry and Richard plot to use Bernie to find treasure he had buried at the Virgin Islands. Before stuffing the body into a suitcase and heading for fortune, however, Bernie is partially revived in a botched voodoo ceremony and made to walk toward the hidden treasure whenever he hears music.

Ah, the sequel. Always a little more extreme and outlandish than the original. But the lesson remains: when in doubt, revive the body any way you can.

The Fed learned the lesson well. So they went back to their old trick and did the same thing they did back in the early 2000s, except with a few new tricks. We've lowered interest rates to near zero, we've pumped almost a trillion dollars into banks, and we've passed an enormous stimulus package. And the result is, we've massively devalued the dollar and made it stupid to hold cash or to save. And so, once again, we're seeing inflation in assets like the stock market, where cash has headed for safety from inflation. And, voila, housing prices are ticking back up in some markets.

But this isn't necessarily a real uptick. Instead, the nascent recovery is more like a Weekend at Bernie's recovery. We're walking around with a dead body and sipping our cocktails. When the music of low interest rates plays, the economy will dance. But it's not really alive. If you wanted to be cute, you might even call this another form of voodoo economics.

A lot has been made of the fact that the VIX (or "fear" or "volatility") index is today at its lowest point since the crisis began. But the VIX doesn't just go around asking people how fearful or volatile they feel and come out with a number. The VIX is a measurement of volatility in stock prices. It's a measure of the potential of stock prices moving up or down drastically. Inflation expectations make it very unlikely that stock prices can move drastically lower -- inflation potential means that cash is still risky, so selling stocks for cash is still a bad move. But people are still uneasy about the future of the economy, so it's hard to see the stock market moving much higher. Therefore, the consensus seems to be that we'll trade in a range. Just like the Fed wanted, they've put a floor on an absolute collapse in asset prices, but by doing so, they've put a ceiling on how quickly we can recover. And like dead Bernie's blood pressure, our volatility is low.

I think this is the basic message of what's happened in the past year. We averted full-blown deflationary castastrophe (getting nabbed by the cops on accessory to murder charges and sitting in deflationary jail for several years), while setting in place an inflationary scenario where a true, healthy recovery is unlikely.

There's a reason it was only a Weekend at Bernie's. At some point, everyone will find out that without Larry and Richard hauling him around (which can't be sustained forever), Bernie would fall down. And without the Fed keeping interest rates dangerously low (which can't be sustained forever), the economy might fall down.

Not even in the movies can you haul a dead guy around a party pretending he's alive for more than a weekend. Let's hope that we've got a long weekend coming up.