The new Fed

Malaysian Business, Nov 16, 2005 by Bishen Bedi

BACKED by the world's biggest economy, the Federal Reserve is far more powerful than any other central bank in the world, and Alan Greenspan was called the world's second most powerful man for good reason. The Washington Post's iconic journalist, Bob Woodward, hailed the retiring Fed boss's policies as delivering the `Greenspan dividend' and the `Greenspan effect'. `Not only is [Greenspan] a major figure in the world's economic past,' wrote Woodward in his book Maestro, `he is central to its future'.

At six feet seven inches, the 79-year-old Greenspan has towered in his position. Among his notable achievements: his rapid response to the stock market crash of October, 1987, shortly after taking office as chairman; battling the effects of the Asian financial crisis of 1997; dampening the damage from the tech bust in 2000; and averting the economic effects from terrorist attacks on Sept 11. Since then, Greenspan has been responsible for hauling the world's biggest economy out of recession, and all this by managing monetary policy, which the rest of the world takes seriously. For when Greenspan talks, the world stops to listen.

So, who's `Gentle Ben' Bernanke, the new Federal Reserve Board Chairman? For the last three years, Bernanke, 51, has been one of the Fed's governors who would meet every Monday morning around a large polished mahogany table to discuss the US's economy and the banking system. A former Princeton University economics professor with a keen eye on statistics and mathematical economic modelling, Bernanke has always sought the `deeper meanings' of data. And despite Greenspan's elegant explanations, he'd insist on unravelling the data more, with his standard clichintd but respectful interjections, `be that as it may', which has become an in-house joke at the Fed and on Wall Street. Data unravelling has become a fixation for the incoming Fed boss.

And the data that most concerns Bernanke? Targeting and fighting the demons of inflation. It's an old story but for monetarists, a demon they've consistently failed to exorcise. In fact, Bernanke wants not just the Fed but all central banks to get back to the main game of making public announcement of the Fed's inflationary targets through `constrained discretion'. And to that end he wants not just the Fed to be shrunk but also all central banks, who he says have taken their eyes off the real ball game. Be that as it may, Bernanke should note, and he probably does, that like the Fed, all central banks have been politicised to a greater or lesser degree, and in most developing countries, there's greater political interference in what ought to be an autonomous institution insofar as monetary policy settings go.

But the Fed's shrinkage isn't a Bernanke design; it's the inevitable result of the greater free flows of money and finance, and more so as the US economy remains heavily indebted, with whopping twin deficits, and as such becomes increasingly dependent on foreign borrowings and investments to stop the economy tripping over the edge. Regardless of the size of the Chinese economy, itself more wonky and unsustainable every day, the world's export-dependent economies rely heavily on the US sucking up the world's growing production of manufactures and resources. The trick is to sustain this growth rate but even Bernanke knows there are limits to growth - unless his political masters tell him otherwise. And an increasingly desperate second Bush administration, with policy failures left, right and centre, will impose its political will on the dogmatist academic Bernanke.

Bernanke's academic inflexibility is something that worries Wall Street Fed watchers in a way that they have not of Greenspan, despite some bristling here and there as Greenspan kept his finger on the interest rate lever. But as Businessweek has argued, the era of central bank heroes is over. Nearly half of US government debt is held by foreigners, and Bernanke will learn to renegotiate the Fed's monetary policy settings with other influential central banks, including the European Union, Japan and China, now that it has floated its currency. Bernanke will continue to oversee the Fed's main role: the ability to print dollars at will, yield regulatory clout over banks, and control over short-term interest rates. But there is no way the US Fed can go it alone again. The proportionality of risks lies now squarely and increasingly with the US economy, and its yo-yoing stock market in recent months suggests investors are iffy about just where the Fed and the Bush administration are taking the economy.

That's the big worry for Wall Street's Fed watchers: Will Bernanke be able to stride out on his own in the way Greenspan has, and strike a consensus among investors, bankers, financiers and the world's major central banks for a common good? That depends on just how things play out at the White House. But it also depends if Bernanke has the persona, the image, before the cameras, to carve the kind of influence which he can then peddle as strongly and powerfully as Greenspan has. Greenspan's shoes are large, and Bernanke has the task in front of him.