Page 1 of 5 POWER WITHOUT CREDIBILITY,
Part 1 Bogged down at the Fed By Henry CK Liu
The announcement during Democrat President Barack Obama's summer vacation that
he has reappointed Ben Bernanke, a Republican first appointed as Federal
Reserve board chairman by president George W Bush nearly four years ago, to a
second term, served to divert attention from unwelcome figures released on
August 25 by the White House budget office.
These forecast a cumulative US$9 trillion fiscal deficit from 2010-2019, $2
trillion more than the administration estimated in May. The federal government
will spend $2.98 trillion in fiscal 2009, $3.766 trillion in fiscal 2010 and
$5.307 trillion in fiscal 2019, all substantially more than projected revenue.
Moreover, the figures show the national debt doubling by 2019 to
$20.78 trillion, reaching three-quarters of the projected gross domestic
product (GDP), with alarming projections of additional $2 trillion from $12.8
trillion in 2009 to $14.5 trillion in 2010.
In fiscal 2008, according the Bureau of the Public Debt, a division of the
Treasury Department, the federal government paid $451 billion in interest on
the debt. In July 2008, the Treasury was paying an average interest rate of
4.382% on that debt. A year later, in July 2009, Treasury was paying an average
interest rate of 3.418%, even as the Fed was doing its utmost to keep interest
rates down. If interest rates go up in the out years as expected, the Treasury
would be forced to pay more per year to service the national debt - even if the
debt itself did not grow.
The president characterized Bernanke's reappointment as seeking to keep "a mood
of stability in the financial markets" while acknowledging that economic
recovery can be expected to be a long way off. The reappointment was a sign of
continuity of long-standing Fed monetary policy in contrast to Obama's campaign
rhetoric of "change we can believe in".
Bernanke is closely identified with Fed policies that landed the global economy
in its current sorry state. Many people, particularly conservative Republicans,
Blue Dog Democrats, and even progressives, are concerned about Obama's
proposals to expand the powers of the Fed, in view of its history of persistent
failure to spot and preempt pending systemic financial crises. Critics question
the wisdom of giving an institution with such a poor record of performance the
prime role as a systemic risk regulator in the proposed regulatory overhaul of
the financial system.
Opposition to the reappointment of Bernanke can be traced to three aspects. The
first is ideological: despite Bernanke's subscription to Milton Friedman's
non-provable counterfactual conclusion that central banks can eliminate market
crashes with timely and aggressive monetary easing, Bernanke is on the same
ideological side of his predecessor - serial bubble wizard Alan Greenspan - who
argued that monetary authorities are best positioned to clean up the mess after
the bursting of asset bubbles than to pre-empt the forming of the bubble
itself. This ideological fixation of the Fed's proper role as a cleanup crew
rather than the preventive guardian of good systemic health, which Greenspan
has since acknowledged as a grievous error, eventually led to the systemic
financial collapse of 2007. (See
Central bank impotence and market liquidity, Asia Times Online, August
24, 2007.)
The second aspect is analytical: Bernanke, as Fed chairman-designate waiting
confirmation, argued in a speech on March 29, 2005, while still a Fed governor,
that a "global savings glut" had depressed US interest rates since 2000.
Echoing this view, Greenspan testified before Congress on July 20 that this
glut was one of the factors behind the so-called "interest rate conundrum",
that is, declining long-term rates despite rising short-term rates.
In reality, there was no savings glut, only a dollar glut that went overseas as
US debt from trade deficits and returned to the US as savings of low-income
Asians because of dollar hegemony in which Asians cannot spend dollars in their
domestic economies without inflation. (See
Of debt, deflation and rotten apples, Asia Times Online, January 11,
2006.)
The third aspect relates to policy: Bernanke is a card-carrying market
fundamentalist who believes that markets can best be self-regulated. He and
Greenspan repeatedly opposed financial-market regulation beyond even
ideological grounds to argue also on the operational ground that US regulation
would merely drive market participants overseas to less-regulated jurisdictions
and that the US will not accept international coordination that threatens
national sovereignty. On regulation, Bernanke is of the school of "if I don't
smoke, somebody else will". (See
Fed's pugnacious policies hurt economies, Asia Times Online, January
10, 2004).
Need to rein in the wayward financial sector
In the aftermath of the outbreak of the financial crisis in July 2007, summit
meetings of world leaders have repeatedly focused on the need of international
coordination of financial regulatory regimes. In an interview with the
Financial Times, UK Prime Minister Gordon Brown expressed hope that the third
Group of 20 leaders summit meeting, to be held in Pittsburgh this month, would
agree on a "global compact for growth" that would include coordinated steps to
withdraw stimulus packages and government support for banks, adding that the UK
could not be expected to take action unilaterally on outsized banker
remuneration.
Lord Adair Turner, chairman of the Financial Services Authority (FSA),
Britain's top banking supervisor, now supports the idea of new global taxes on
financial transactions, warning that a "swollen" financial sector paying
excessive salaries has grown too big for society. This is an idea that is
equivalent to a financial parallel to the Kyoto Protocol on climate change,
which for years the US dragged its feet in supporting.
In an interview in Prospect magazine published on August 27, Lord Turner says
the debate on bankers' bonuses has become a "populist diversion" from the real
need for more drastic measures to cut the financial sector down to size. He
also says the FSA should "be very, very wary of seeing the competitiveness of
London as a major aim", claiming the city's financial sector has become a
destabilizing factor in the British economy. The Bernanke Fed has yet to take
similarly progressive positions in response to the financialization of the US
and global economies and the role Wall Street plays in them.
On all three aspects, there are no signs that Bernanke has turned a new leaf
intellectually or professionally from his sordid past. His dysfunctional
fixations have impaired the effectiveness of the Fed's unconventional policy
directions and unprecedented rescue actions in dealing with the two-year-old
financial crisis. The Fed's radical surgery is only revolutionary in
operational protocol, aiming to keep the patient alive longer with the disease
rather than to cure the disease.
Bernanke, the incredible hero
Yet for Wall Street, Bernanke has become the hero of the hour. Not
surprisingly, since his self-described "bold and creative" actions in the
financial crisis have saved Wall Street from imminent total suicidal collapse
at the expense of the long-term health of the economy and the sustainable
strength of the dollar.
This is the hero who on March 28, 2007, some 100 days before the worldwide
spread of the US subprime mortgage crisis, told the Joint Economic Committee of
Congress: "To date, the incoming data have supported the view that the current
stance of policy [with Fed Funds rate target at a high 5.25%] is likely to
foster sustainable economic growth and a gradual ebbing in core inflation."
Bernanke challenged market expectations of early Fed interest rate cuts, saying
he was comfortable with rates on hold despite adverse economic data. This is
the monetary equivalent of the captain of the Titanic ordering "steady as she
goes" with a huge iceberg 100 yards ahead.
In the same testimony, Bernanke signaled that Fed policy had not shifted to
even a neutral policy stance "away from an inflation bias", let alone an
accommodating stance in response to an imminent crisis that he failed to see
coming at him like a runaway train at full speed. His remarks helped prompt a
near 100-point fall in the Dow Jones Industrial Average the next day.
Bernanke also brushed aside comments by Greenspan, his predecessor who at last
began to see the light, that the expansion looked to be "aging", implying the
possibility of a recession on the horizon. More ominously, Bernanke played down
the threat from the subprime mortgage market on even the US financial system,
let alone the global system, which the US component dominated. He missed
entirely the fast-closing window of opportunity to stop the housing bubble from
bursting abruptly with massive timely injection of money into the banking
system.
Instead, Bernanke told Congress in a tone devoid of any sense of urgency: "The
magnitude of the slowdown has been somewhat greater than would be expected
given the normal evolution of the business cycle." And he dismissed as alarmist
the concern of some market analysts and participants over the clearly visible
signs of distress in the subprime mortgage market and its serious systemic
impact globally.
"At this juncture ... the impact [of the distressed subprime mortgage market]
on the broader economy and financial markets ... seems likely to be contained,"
he said in a statement that will go down in history as being as infamous as
president Herbert Hoover's "prosperity is just around the corner" after the
1929 market crash.
Bernanke also told Congress that consumer spending "has continued to be well
maintained so far this year," and consumption "should continue to support the
economic expansion in the coming quarters". The economy has not recorded an
expansion in the five quarters since that pathetic pronouncement and the
consumer spending well has run dry.
Eleven days earlier, and four months before the credit crisis broke out in
July, I had warned my readers about the inevitability of a global systemic
crisis (see Why
the subprime bust will spread, Asia Times Online, March 17, 2007.)
It is a puzzle that the chairman of the Federal Reserve, even with the benefit
of a huge research and analysis staff, supported by privileged access to early
data, backed by a peerless academic reputation, could miss what appeared
obvious to a lowly independent observer relying on the mass media for
information.
Two years before the credit crisis broke out in July 2007, I wrote:
The
Kansas City Federal Reserve Bank annual symposium at Jackson Hole, Wyoming, is
a ritual in which central bankers from major economies all over the world,
backed by their supporting cast of court jesters masquerading as monetary
economists, privately rationalize their unmerited yet enormous power over the
fate of the global economy by publicly confessing that while their collective
knowledge is grossly inadequate for the daunting
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