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Bernanke is being way too cautious

Fed Chairman Bernanke's remarks today were designed to justify the continuation of ultra-accommodative monetary policy. To be sure, the economy is suffering from a huge "output gap," but nevertheless, there are plenty of signs that things are improving on the margin.

The economy is definitely creating new jobs, and it's even possible that jobs are growing at an accelerating pace, as suggested by the household survey of private sector employment in the chart above. The economy is likely still well below where it should be, but if current trends continue there will be a full jobs recovery within a year or so. We don't need cheap money to make that happen, we just need to let the natural forces of recovery and growth do their thing. The profit motive is a powerful source of growth, and left to their own devices entrepreneurs and workers will expend lots of effort to figure out how to work harder and more efficiently.

One of the big reasons the last recession was so deep and protracted was that the market's fear of a global financial collapse and depression reached extremely high levels. It's taken three years to slowly and gradually erase these fears, and both the equity market and the economy have responded rationally to the reduction of perceived risk by growing.

Equities have also tracked the behavior of unemployment claims. Claims are a good proxy for the degree to which the economy has to make painful adjustments. The economy had to shift massive amounts of resources away from the residential construction and banking industries into other areas. With claims now close to returning to "normal" levels, it's not unreasonable to think that most of this painful adjustment process has been completed. Going forward the economy is going to do more of what comes naturally—grow—rather than slash and burn. Fear has returned to more normal levels, and most of the painful adjustments to new economic realities have been completed, so it is not surprising that equities have recovered much of the ground that they lost .

What's still lacking, however, is confidence in the future. As this chart shows, Treasury yields are extremely low, and have only responded weakly so far to signs of improvement in the economy. When I see 10-yr Treasury yields at or near 2% I can't help but think that the market holds out almost no hope of any meaningful economic growth in the years to come. I think Bernanke's repeated expressions of concern, and the Fed's continued willingness to pull out all the monetary stops in order to goose the economy, are contributing to the market's pessimistic outlook.

Investors are still shell-shocked from the events of a few years ago, so they have little problem believing that if it weren't for ultra-accommodative monetary policy and massive fiscal deficits, the economy would sure enough slip back into a recession. Investors think the economy is on life-support, whereas to me it looks like the economy is recovering in spite of all the ministrations of Washington.

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