History Reserves A Sad Place For The Next Fed Boss

Friday, October 28, 2005

The nomination of Ben Bernanke, head of US President George W. Bush's Council of Economic Advisers (CEA), as successor to Federal Reserve Chairman Alan Greenspan has sparked a hot international discussion about the future course of US monetary policy.
The academic world fiercely debates whether Bernanke will be a "hawk" who is not afraid to fight inflationary pressures with higher interest rates or a "dove" who prefers to let the stuttering economy rumble ahead on a cushion of cheap credit. But gyrating capital markets obviously fear the latter.
Ben "Printing Press" Bernanke's reputation is engraved in stone with weary asset managers since he said in a speech in November 2002,"the US government has a technology, called a printing press - or, today, its electronic equivalent - that allows it to produce as many US dollars as it wishes at essentially no cost."
Such a stance certainly pleases Bush who has been running up more debts than any other president in US history and is for this reason actually the biggest enemy to a sound monetary policy in times of rising inflation. Public debt jumped from US$5.8 trillion to more than $8 trillion (that is $8,000,000,000,000) since he took office in 2001, and he is the first president who has never vetoed any costly bill Congress has presented to him.
Be it $80 billion per year for the war in Iraq on top of the $430 billion the Pentagon needs to keep its war machine running on idle, $225 billion for a renovation of the US highway system (including a $220 million bridge to an uninhabited island in Alaska) or some $200 billion for rebuilding efforts after the hurricanes in the southern US, Bush has always been a happy spender. At the same time he has aggravated the fiscal situation by numerous tax cuts benefiting the upper crust of America's society. By the time Bush goes home, the US debt will scratch the $10 trillion level.
A Free-Spending Bush Is Bernanke's Worst Enemy
Uncertain times lie ahead. The man who gave Bernanke the job is actually his worst enemy. While Greenspan is trying to save his legacy as the Fed chairman who oversaw the longest peacetime expansion of the US economy from 1987 to 2001 by notching up the leading interest rate in baby steps of quarter percentage points and has difficulties keeping energy-induced inflation in check, Bernanke has a lot of work at hand to build a reputation of being as independent of the White House administration as Greenspan was.
Being groomed in the White House before his return to the Fed, where he served as a governor for three years before his current tenure into Bush's innermost circles, is certainly not of help. At his post in the White House Bernanke missed the chance to caution Bush against a continuation of the explosive growth of US government debt.
Greenspan Did Too Little, Too Late
US inflation, meanwhile, has already accelerated to an annual rate of 4.7% in September, up from 3.3% at the end of 2004, a trend that could derail Greenspan's reputation from being "The Maestro" to simply "Easy Al" who will be remembered for doing "too little, too late", his predecessor, Paul Volcker, said in April.
The mandate of the Fed is a delicate issue, as the world's most-important monetary authority has not only to guard against inflation - which it does by raising interest rates - but also has to keep employment at the highest-possible level, which is achieved by low interest rates that encourage businesses to invest.
While Greenspan came from the private sector and was described by his colleagues as a data-driven chairman with little regard for ideology while on the job, Bernanke's last position at the CEA certainly puts him much closer to the happy spenders in the White House and Congress, where most Republican politicians see no problem in keeping the money-tap wide open. They trust that China and the other Asian exporters will stay forever happy selling their goods for evermore American debt paper, which are just an obligation to pay later.
The US itself has little left that it can export save for the US dollar and ATPs - Advanced Technological Products, a euphemistic term for a combination of weapons and computers used in the trade-deficit statements. But even as the biggest arms dealer in the world, US sales of killing devices no longer outweigh the imports of computers manufactured mostly in Taiwan and China.
In the first eight months of 2005 the trade deficit widened from $427 billion to $500 billion compared to the same period a year earlier. A nation once envied for its textiles (jeans), big cars and computers, "Made in the USA" has become a second choice for the same products now manufactured by the new industrial giants, China and India.
The game has worked so far because the rest of the world could rest assured, knowing their dollars would always be a stable reserve currency happily accepted by all.
Rising Inflation Is The Biggest Threat
Rising inflation has changed this picture altogether. China is building up a strategic petroleum reserve financed by selling part of its gigantic dollar holdings, which is a result of the fact that commodities are becoming reserve currencies these days.
Russia has quietly lowered the dollar part of its total foreign-exchange reserves from 90% to 70%. South Korea's announcement to diversify out of the dollar sent the dollar into a free fall for a day until its central bank issued a statement that it did not plan such a move, only again to renounce this statement a day later. Japan, with $800 billion the biggest holder of US debt papers, just remains silent as it knows it has no cheap way out of the dollar-devaluation dilemma. If markets get the idea that Japan is starting to sell its dollar papers, the US currency would certainly start a tumble that could turn into a crash that would lead to global impoverishment since 75% of all investments are denominated in greenbacks.
Problems On Several Fronts
Now Bernanke faces problems on several fronts, and the world, especially capital markets, will watch his every move closely. If he is to keep the dovish Greenspan policy of baby interest-rate steps he risks losing on the inflation front, with energy prices surging anew in the face of a growing supply-demand gap. This can lead to a devaluation of the dollar as its holders will try to get rid of a currency that buys less and less every month.
Playing the hawk, on the other hand, and propping up the dollar with higher rates could lead the US economy into a low- to no-growth environment, a situation Bush will probably try to prevent at literally all costs before the mid-term elections in 2006.
Taking from his first remarks at Monday's news conference, which were a kowtow to Bush, I am more willing to gamble on a dovish Bernanke. The world has seen enough examples of how the White House wipes out critical voices at all levels.
Gaining the same credibility as Greenspan, whose words can make markets turn on a dime, will be a tough task for Bernanke, whose bio shows a long list of academic credentials but not that much on-the-job experience. Skeptics fear he will rely too much on economic models and to a lesser extent on current data.
But there are also enthusiastic endorsements of him. James D. Hamilton, professor of economics at the University of California in San Diego, wrote in an initial reaction: "I've disagreed with Bernanke on a number of specific issues over the years ... But I will be doing so from a position of respect for the new office holder". Hamilton called him a first-rate mind.
The former economic adviser to president Bill Clinton, Brad Setser, wrote that Bernanke "probably appeals more to the center and the center-left than the supply-side right".
Interestingly Republicans voiced more concerns. The National Review, a haven for dyed-in-the-wool conservatives, has been launching hit-pieces against Bernanke, although little validity can be attributed to their frothy criticism.
A Sad Place In History?
Bernanke, 51, will certainly try his best to serve the maximum term of 14 years at the top of the Federal Reserve Board and keep the American economy in the best shape possible. But the son of a pharmacist and a teacher from South Carolina could be handed a sad place in history and it will not be his fault.
Not even the most brilliant head at the Federal Reserve Board will be able to prevent the decline of the American empire as long as we see a continuation of the policies made by the persons currently residing in the White House.
The questions of the future are not so much whether Bernanke will be a hawk or a dove. The question is whether the US government will find out soon enough that in an interconnected world they can no longer follow a petro-theist foreign policy financed with the money of others.
Looking at the numerous problems the US government faces - and taking into account that not one of them has yet been addressed - the major problem is not whether one brilliant economist with loads of academic credentials replaces another. Rather, it lies much more with the future course of American policy and the results of it on its economy. Or let me say it this way: The problem is not A(lan Greenspan) or B(en Bernanke) - it is (George) W (Bush).
NOTE: This piece was first published in Asia Times Online.
UPDATE: As I was busy otherwise yesterday I found out only now that Harriet Miers has requested a withdrawal of her nomination to the High Court. As the officers desert their general I would not bet all chips that this is the last high-level defection in Bush's core team. Ahem, sorry, I forgot the independent status of the Fed chairman...


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