By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
It has been almost a week since the Bernanke testimony and since the dust has settled, two exchanges stand out in my mind. They are not the most incendiary moments or the most vitriolic remarks; however, I believe that Bernanke’s answers say a great deal about the Fed.
Bernanke Grades the Fed on a Curve and Awards It a Pass
Early in the testimony, Senator Shelby asked Bernanke whether or not he (Bernanke) thinks the Fed did a satisfactory job of supervising and regulating financial institutions prior to the crisis. (I do not remember the exact words.) Bernanke responded: “We didn’t do a perfect job by any means, but I don’t think we stand out as having done a worse job than other regulators.” While confession maybe good for the soul, I do not think that Bernanke did the Fed a favor with that response. Given the SEC’s performance, the phrase “damning with faint praise” comes to mind.
At a later point in the testimony, Bernanke pointed out that many of institutions and instruments at the heart of the crisis were not the direct responsibility of the Fed. Still, if the Fed cannot make positive arguments for retaining supervisory/regulatory responsibilities, then the odds of the Fed retaining a supervisory role just dropped.
Bernanke Avoids a Domestic Political Problem by Exacerbating an International Policy Problem
At one point, Bernanke was asked if the low interest rates were fueling price bubbles in commodities and other asset prices here and abroad. The WSJ reports his response as follows:
The Fed chief said near-zero interest rates were not fueling asset price bubbles in the US and that it was not the Fed’s job to prevent bubbles abroad. “US monetary policy is intended to address both financial and economic issues in the US,” he said. “Countries that are concerned about that have their own tools to address bubbles in their own countries.”
This was the answer that the Senators wanted to hear, but it will not be without negative consequences — the veracity of the statement that policy is not fueling asset bubbles domestically aside. When US officials suggest/request that other countries change their exchange rate policies to help correct the US trade deficit, who do you think their foreign counterparties will quote? The already low chances for a cooperative unwinding of the global imbalances got lower.
Bernanke is not just the head of an important central bank. He is the head of the central bank that issues the world’s reserve currency. For decades, the US has benefitted from the Dollar’s reserve status, e.g., lower interest rates and lower inflation and exchange rate volatility. Now, Bernanke asserts that it was all a free lunch. Reserve status imposes no responsibility on the US, which is free to set policy that will contribute to trade deficits and lead to the depreciation of the Dollar (and the value of Dollar reserves) in terms of other currencies as well as in terms of commodities.
Furthermore, in the past, many countries that currently hold Dollar reserves experienced problems arising from external imbalances. In exchange for international help, they were required to adopt a range of policies including fiscal and monetary austerity, exchange rate depreciation as well as financial market restructurings while surplus countries were not required to adjust their policies. The policy mix was referred to as the “Washington consensus”, as the driving forces behind the arrangements were the IMF and the US Treasury. Now they will see the US as requiring them to adjust policies so that the US can avoid any domestic adjustments, even though the US has fiscal and external imbalances and was the epicenter of the financial crisis.
US standing in the world fell when Washington assumed that everyone shared “American” values. The US standing will fall even faster if Washington expects other countries to surrender policy freedom and experience lower rates of growth so that the US can run policies of its choosing while pursuing economic growth.
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Can the Chinese pick up the gauntlet and screw this menace for the US and world economies…
Interest rates are being kept low in Canada so as to prevent the CDN dollar rising against the US$: wouldn’t want to charge the US too much for our raw materials, eh?
Oh and our residential real estate keeps going up in price.
And also, our central bank chief is a forty-something ex-Goldman Sachs man.
The former Canadian Central Banker (Dodge?) seemed far more sane. I have no idea what possessed the government to replace Dodge with this Carney nut.
“our central bank chief is a … ex-Goldman Sachs man”
The other day I suggested that the polar bears be let out of the Central Park zoo in Manhattan and allowed to eat all the investment bankers they want. Canada has plenty of polar bears, so you can take care of your own problems.
As Yves posts today on Calls For Protectionist Retaliation Against China Rise (and has posted similarly on several occasions recently), the sentiments (at least as proffered by Alber & Wolf in above link) regularly ignore the conditions underlying Bernacke quote you hi-light.
From Yves’ link (Alber):
I see this notion expressed frequently by a bunch of these guys: that we can flip a switch and move “our” manufacturing to some other not-quite-yet-emerged foreign economy… and somehow expect a result whereby their workers benevolently maintain long term, low wage production of all us Americans desire.
The dichotomy in world wide economic production vs. who gets the goods and profits… it’s as evident in Bernacke’s statement as it is in observing who’s doing the actual work on the blue planet.
The hubris of (especially) US “free marketers” relying upon historically dominant US production/technology etc. while said dominance is largely a relic… I don’t know.
I see your highlights as markers of very, very precarious US econ/monetary situation, with no corrections in sight.
I think the following paragraph contain a key observation for the understanding to the nature of the current economic problems:
This notion of “Washington consensus” makes Yves arguments about China currency manipulation expressed in earlier post extremely weak and unconvincing. In the discussion that followed AC pointed one of the key weakness of Yves reasoning in the following way:
In other words it takes two to tango. US-China alliance was beneficial to both countries but in quite different ways. China allowed the US multinationals to exploit the low cost labor to keep employment high and its industry modernizing. The US was happy to grow the FIRE
sector instead of real economy and finance foreign adventures using cheap China provided loans (guns and butter policy).
My impression is that exporting dollars and increasing external debt was deliberate policy decision (with Chinese as willing accomplices of the crime) aimed to allow USA FIRE sector became the world dominant and convert the USA into new Switzerland of the world, the central banker and keeper of all other countries reserves with its
financial services positioned as the dominant provider of investment and wealth services for all other countries (I remember desperate cries about importance of opening China financial markets for GS and like…). That might also help to explain the recent opposition to dismantling TBTF institutions by Obama administration.
“This notion of ‘Washington consensus’ makes Yves arguments about China currency manipulation expressed in earlier post extremely weak and unconvincing.”
Why?
“it takes two to tango”
The exact phrase that Yves used in comments (although I suspect neither of you coined it).
Seriously, what’s your point? That the US was/is complicit in Chinese currency manipulation for the benefit of the US FIRE sector? I agree, and it’s hardly a radical point. Nor does it make the problem any less.
Want some evidence? Robert Rubin and his protege Larry Summers were proponents of the “strong” dollar as far back as the Clinton administration, and it’s no secret that they’re FIRE men all the way.
Screw manufacturing. Why build things when you can loot your way to riches (Rubin made $60M+ from the great job he did at Citi after retiring as SecTreas).
Alex: Why?
Because weak currency is the essence, immanent feature of the USA China policy and to complain about it is the same as to complain that water or fire cause destruction, if misused. A very simple example.You can buy on eBay a USB car charger directly from China for $0.99 (plus $3.99 shipping). The same charger is $14 in Wal Mart. Just think about implications for the USA as a whole and obscene profits for multinationals. BTW threat to substitute China for Philippines change nothing in this ratio ($1 Asian manufacturer, $10 or so the US distributor). If you impose $1 tariff on the charger it’s Wal Mart that need to pay it. All that Asian manufacturer can pay is 10 cents or less. Now you probably understand that such tariffs are pretty low on the agenda of the current administration. We need to answer one simple question: who is the most interested party in this currency manipulation, so to speak ?
Alex: “it takes two to tango” The exact phrase that Yves used in comments (although I suspect neither of you coined it).
This is a common idiom which suggests something in which two sides are paired. Occasionally with negative connotations. Like in case an addict and his supplier. The quote that you refer to:
How you can call something to be "flagrant violations of the rules of the game", if this is was the cardinal rule on which the game is based, the rule that both players voluntarily agreed from the very beginning? US did not foresee some side effects of this poker game, as hypertrophied FIRE industry became self-destructive instead of feeding the whole country population, which was meanwhile freed from the
burden of manufacturing "real goods" and moved to the "service economy"
But even this is a revisionist version of the original Yves’ post, which expressed stronger (and more simplistic) view on currency manipulation:
Sorry, but I can’t agree with such a statement.
kievite,
With all due respect, do you know anything about trade? Do you know ANYTHING about the history of the RMB peg against the dollar? Your remarks suggest not. You comment approvingly of what AC said, when as other pointed out, does not understand even the fundamentals of foreign trade accounting. Yet you read clear explanations of why he was off base. That suggests you’d rather cling to your comfortable prejudices than fill in gaps in your understanding.
I suggest you go read up on WTO rules before you offer uninformed views about what is and is not permitted under them. Yes, the US chose not to go after China, for as much geopolitcal reasons back then (we liked the idea of a Commie country acting more and more capitalist) as economic. But your argument about currencies is just 100% inaccurate.
Geithner did in fact use “currency manipulation” after he was Treasury secretary and got the expected heated denial from the Chinese precisely because it is a WTO violation. And it has been going on since 1994. No one cared much early on because the rate China set initially was pretty close to what the market rate would have been. But the failure to increase is (and the currencies of developing countries always appreciate) left China with a significantly undervalued currency, and it has been preserving it at that low level by buying dollar assets.
Yves, I apologize for using too strong language, but I do not have “comfortable prejudices” (aka agenda). I just tried to understand the issue better and weight the arguments.
I agree that this is a very complex and somewhat emotional topic and that I do not understand many details that are known by specialists.
You run an excellent blog that I highly value. That’s why I commented on your post.
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