There is a whiff of panic in the air. Ben Bernanke has indicated his willingness to ease monetary policy substantially and that means much lower interest rates. Anna Schwartz, well known for the work she co-authored with Milton Friedman on the monetary history of the US, has delivered her verdict on the US Federal Reserve. She said the subprime crisis would not have occurred had the Fed led by Alan Greenspan in the early part of this decade been more alert. Now, Bernanke wants to set right the mistake created by loose monetary policy with even looser monetary policy.
In a recent speech covering several paragraphs, Bernanke devoted one small paragraph to inflation. The Fed is responsible for both full employment and price stability. Rarely in recent times has the Fed been compelled to choose between the two as starkly as it is being required to. Bernanke and his colleagues initially offered a tough line on inflation. The political pressure and pressure from financial institutions have won in the end.
America is ready to flood the world again with more dollars on top of the mountain of dollars that the world is already sitting on. The only thing is that it might work this time—in creating inflation globally and a free fall in the dollar.
As though that were not enough, there were rumours that the Fed played a role in the takeover of Countrywide Financial Corp. (CFC) —a mortgage lender and a poster child for all the wrongs committed by the industry in the last several years—by Bank of America. If this is true, then America’s commitment to capitalism is worse than symbolic. It is antagonistic. If the US had come around to thinking that its economic virility would be questioned even if one institution went under, then it is time for all of us to shed our dollar holdings because what follows from such thinking is that whatever is necessary to keep every failing institution alive would be pursued zealously. That is exactly what Bernanke hinted at in his speech last Thursday.
American financial institutions on their part are rushing to their friends in the Arab sands and in China with the sole intent of self-preservation. They appear to be either indifferent or naïve about the strategic implications of their approach towards sovereign wealth funds from non-transparent countries to recapitalize themselves. As Brad Setser writes in his blog (“Wall Street, the new development frontier”, 12 January), America has traditionally been leery of government involvement in commercial firms. Now, non-transparent foreign governments are being invited to be involved in them by the firms. We do not know if the American government has decided to look the other way. If so, the rot must be a lot deeper.
If these are still not persuasive enough to dump the dollar, the following piece of news should do the trick: The CEO of CFC is likely to receive $110 million as severance package for the mess he has created in CFC and in the US mortgage industry. The next question is to sell the dollar against what.
America provides the answer for that, too. It’s easier monetary policy and the status of the dollar as a global reserve currency held in increasing quantities by central banks is forcing other central banks to hold back on their (needed) monetary tightening or even reduce interest rates. That is done to prevent excessive appreciation of their currency against the dollar, particularly when China is showing no great urgency in revaluing the yuan on a trade-weighted basis. As a result, most countries now have monetary policy settings that are inappropriate to their domestic economic needs.
Thus, after five years of strong growth, economic activity is being stoked at the wrong time. Demand for commodities refuses to slow. That is why, despite the threat of a recession in the US, the price of crude oil is well above $90 per barrel. Consequently, inflation numbers are running well ahead of estimates in most countries. America ends up importing this inflation with its weak dollar.
Economic stagnation in America results in inflation elsewhere and finally washes up on the shores of the US, too, and that is stagflation.
In the past, speculators attacked the currencies of countries that ran inappropriate monetary policies. Now, countries that still peg their currencies to the dollar loosely or tightly either have closed capital accounts or have large reserves or both.
Hence, speculators cannot exploit irresponsible monetary policy. Market discipline is lost when sovereign wealth funds replace private players in the financial markets. So, the question is: Where do they and where do we all seek refuge? Noticed lately how gold has run up? Now you know why.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at email@example.com