I enjoyed the
remarks attributed to Bernanke that he had thus far failed to change the dress
policy at the Board of Governors from business suits to Hawaiian shirts and Bermuda
shorts. Stephen Roach predicts he
might also want a life preserver. kwc
The Ambush Waiting For
Bernanke
OpEd by Stephen S.
Roach, LA Times, October 26, 2005
Stephen S. Roach is the chief
economist for Morgan Stanley.
Most FED chairmen are blindsided early on in their tenure. Alan Greenspan faced a stock market
crash two months after he took over in August 1987. Paul Volcker had to cope
with a rout in the bond market three months after he became chairman in August
1979. G. William Miller was challenged immediately by a dollar crisis in the
spring of 1978. For Arthur Burns, it was the inflation bogie in the early
1970s.
What's more, this indoctrination by fire has tended to take the new Fed chief —
who is arriving without his predecessor's hard-won credibility — well out of
his comfort zone.
Burns, the business cycle expert, was ill-equipped to cope with inflation.
Miller, the businessman, didn't understand financial markets. Volcker, the
expert on international finance, had to deal with a major recession. And
Greenspan, the business consultant, was thrust into crisis management.
Ben Bernanke, I suspect, will meet a similar fate. It's true that, on the
surface, he seems to be the perfect candidate to deal with the one problem
everyone is worried about today — inflation. The oil shock of 2005 has taken
retail energy prices up 35% over the last year, and there are 1970s-style fears
that a spillover to other prices can't be too far behind.
And Bernanke is widely thought to be the perfect central banker to cope with
this problem. He is renowned for his skills as an inflation fighter. He has led
the charge in the academic debate over "inflation targeting" —
arguing that a central bank needs to be explicit in aligning its policy
instrument (the federal funds rate) with a numerical target of price stability
(a 1% to 2% increase in the "core" consumer price index).
But I suspect that the current inflation scare will turn out to be a false
alarm. As always, energy prices will come down when demand sags — some of that
may already be occurring — and the new and powerful forces of globalization should
continue to hold other prices largely in check.
The U.S. economy actually faces far greater threats than inflation — threats
that an inflation targeter such as Bernanke may be ill-equipped to deal with.
At the top of the list is a record U.S. current account deficit — the broadest
measure of the nation's trade balance (imbalance, in this case) with the rest
of the world. Running at an annual rate of close to $800 billion in
the first half of 2005, it requires foreign funding to the tune of $3 billion per
business day. To
accomplish that without a sharp drop in the dollar and/or a related backup in
interest rates requires extraordinary confidence on the part of foreign
investors in U.S. assets.
The foreign confidence factor could well be Bernanke's biggest challenge when
he takes the reins at the Fed. The nation's current account deficit averaged
just -1.5% of gross domestic product at the three most recent Fed transition
points — the ascendancy of Miller, Volcker and Greenspan.
By contrast, today's deficit is more than four times larger at -6.4%. Moreover,
in the face of an energy shock and a post-Katrina fiscal spending binge, there
is good reason to look for a further reduction in U.S. saving and a related
widening of the current account deficit over the next year.
In short, the U.S. is going to be asking a lot more of the foreign investor at
precisely the moment the Fed is transitioning from Greenspan to Bernanke. As
the maestro leaves the building, the hard-won aura of foreign confidence that
surrounds him could be quick to follow. Bernanke could be faced with a dollar
crisis and the related need on the part of foreign investors to seek
compensation for taking currency risk. That compensation invariably spells
higher interest rates — the last thing the nation's housing bubble and overly
indebted consumers need.
During the Greenspan era, the U.S. economy pushed the envelope in sustaining an
increasingly dangerous strain of unbalanced growth. In doing so, it experienced
an equity bubble, a housing bubble, a record current account deficit and a
monstrous overhang of household debt. The U.S. has gotten away with these imbalances because of
the "kindness of strangers" — the willingness of foreigners to keep
investing in dollar-based assets.
But the confidence that underpins foreign funding of the U.S. is a very fragile
commodity. Fed transition time usually unmasks that fragility. Like the
chairmen who preceded him, Bernanke could quickly find himself dealing with a
confidence crisis. And suddenly, the inflation targeter will be staring at a
far more intractable set of problems than his research and training prepared
him for.
History warns us to expect the unexpected when the nation's second-toughest job
changes hands.
http://www.latimes.com/news/opinion/commentary/la-oe-roach26oct26,0,2699976.story
