Last week’s column was on how America is a nation in denial about the extent of its problems.
I was pleased that Willem Buiter, former member of the Monetary Policy Committee of the Bank of England, has expressed the same view in his blog (http://blogs.ft.com/maverecon/2008/02/a-while-ago-i-a.html). Now Kenneth Rogoff, professor at Harvard and former chief economist of the International Monetary Fund, has pitched in. In an article for Project Syndicate, he writes that America should not hesitate to take advice from policymakers in developing countries since they have seen this movie before: Low interest rates, inflated asset prices, off-balance sheet vehicles, exotic financial instruments and exuberance about the promise of these instruments. He wonders whether the US will be as nimble in taking advice as it was in proffering it, to Japan and to the rest of Asia in the 1990s.
It is unsurprising, therefore, that the public is more sanguine than the intellectuals are. According to Emerging Portfolio Fund Research, investors poured $2.8 billion (Rs11,116 crore) into funds that concentrate investments in financial services companies, the most in four years. A cursory look at financial history tells us that bottoms in stocks are formed not when investors are pouring money in but when they are pulling it out. Such investor behaviour stems partly from a lack of comprehension of the situation and partly from the optimism that interest rate cuts would cure all ills.
Faced with inflation risks and risks of a credit crunch, the US Federal Reserve has wholly concentrated on the latter and ignored the former. That is where it has not only lost its credibility but also displayed an unwillingness to learn from past errors. Given the risk of a big surge in inflation — crude oil price above $90 per barrel, wheat prices at a 60-year high and America’s own headline inflation rate at more than 4% — the Federal Reserve would have been better off being reactive in dealing with economic slowdown risks and proactive in its role as the lender of the last resort. In fact, there is room to believe that it has done precisely the opposite.
The other major central bank in the world has behaved in contrasting fashion and, yet, it has not won sufficient recognition for it. The Financial Times recognized Jean Claude Trichet, president of the European Central Bank (ECB), as its man of the year for 2007. Barring that, ECB has received only derision for being late with interest rate cuts. For better or worse (mostly the latter), American behaviour is the yardstick with which others are measured. ECB relaxed its stance on monetary policy vigilance on inflation only this week. The euro promptly lost value against the dollar. Indeed, a strong case could be made for “rewarding” ECB for having taken its role as the keeper of value for its currency seriously, with a stronger euro.
Instead, the euro fell not only because of the expected diminution of the interest rate advantage over America, but also because the eurozone, despite the vigilance at ECB, has its own share of cupboards with real estate skeletons. Spain, Ireland, France and Greece come to mind with Spain correctly at the top of the list. Spanish real estate and banks might be the straws that break the back of the eurozone economy and the resolve of ECB not to let its fight against inflation fizzle out. If so, one might legitimately query the ultimate effectiveness of the methods of ECB. In reality, a harsh verdict on ECB must be tempered by the fact that the US must share a large portion of the blame.
The global financial marketplace unfortunately lacks a global regulator. America, with its pre-eminent role, sets the rules and others follow it as, otherwise, businesses threaten to move out of perceived unfriendly jurisdictions. Hence, other nations cannot take positions too different from that of the US. Thus, regulatory arbitrage facilitates local risk going global. Also, when the US cut the federal funds rate down to 1% in 2002-03, other central banks were compelled to follow suit lest their currencies appreciated excessively against the dollar and, by default, against the Chinese yuan pegged to the dollar. That partially set the stage for real estate manias even in regions where policymakers were reluctant to emulate the Americans.
In a sense, America’s global dominance is both a blessing and a curse as it grapples with its own financial crisis. It is a blessing because many other nations have a strong interest in not letting the American economy and the currency collapse. It is a curse because it impedes adjustment of financial prices to emerging realities that would force policymakers to take painful but correct measures. For now, the US thinks that it is blessed and that is part of the problem.
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 firstname.lastname@example.org