Post-Bernanke Fed Faces New Era of Thinking Globally

Sunday, 22 Sep 2013 07:35 PM

 

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At the height of the 1998 Asian economic crisis, then-Federal Reserve Chairman Alan Greenspan declared the U.S. was no “oasis of prosperity” in times of global stress.

It is a lesson Ben S. Bernanke’s successor will need to heed upon inheriting a central bank once again facing a domestic need to think internationally.

For five years, the Fed has focused on home-grown challenges, including financial turmoil and the recession and surge in unemployment that resulted. The biggest threat to U.S. expansion under its next chairman may lie outside its borders as China and fellow emerging markets show signs of weakening.

Vice Chairman Janet Yellen is the top candidate to replace Bernanke if he steps down in January, and then would become the top monetary-policy maker as markets open wider for trade and finance and regulators seek more cross-border coordination in monitoring banks.

“The U.S. is becoming somewhat more dependent on what’s going on in the rest of the world,” said Nathan Sheets, the former head of the Fed’s international-finance division and now global head of international economics at Citigroup Inc. in New York. “For Fed policy makers, the U.S. is becoming much more closely integrated with the global economy.”

That shouldn’t prove a problem for Yellen. She has been globe trotting and crisis fighting at the Fed from Washington since 2010, helping to craft bond-buying and communication policies. As president of the Federal Reserve Bank of San Francisco in the six previous years, she monitored Asia and oversaw banks with foreign exposure, including Wells Fargo & Co.

Global Meetings

Her Fed calendars, obtained under a Freedom of Information Act, show her attending meetings of counterparts and regulators in London, Paris, Zurich, Basel, Bern, Helsinki, Mexico City, Tokyo and Shanghai from 2011 to January of this year. In the 1970s, Yellen, now 67, worked in the Fed’s international division and also taught at the London School of Economics.

“I have known Janet for some years,” South African Reserve Bank Governor Gill Marcus said Aug. 13 in Johannesburg. “When Janet talks, you can hear a pin drop. She is methodical, analytical.”

The role of the Fed “has significant international implications,” said Clay Lowery, a vice president at Washington-based Rock Creek Global Advisors LLC and a former U.S. Treasury official. “Janet Yellen’s experience suggests a command of those issues.”

International Exposure

Other contenders also have international exposure. Donald Kohn, 70, served the Fed for four decades, including as vice chairman from 2006 to 2010, and now is a member of the Bank of England’s Financial Policy Committee. Roger Ferguson, 61, negotiated the implementation of new international capital standards for banks as vice chairman from 1999 to 2006 and led the central bank’s response to the Sept. 11 terrorist attacks when Greenspan and other colleagues were stranded outside Washington. He is now chief executive officer of TIAA-CREF.

The need to think globally doesn’t mean the Fed will serve as a central bank for the world under the new chairman, providing monetary support at times of overseas strain regardless of whether that’s best for the U.S.

Federal Open Market Committee members, including Atlanta Fed President Dennis Lockhart, left no doubt where they stand after developing-nation asset markets and currencies slid this summer when the Fed signaled it may begin tapering its $85 billion program of monthly asset purchases. The fallout prompted calls from the International Monetary Fund, Mexico, China and other emerging economies for the Fed to communicate better or even coordinate more when it does begin to withdraw.

U.S. Mandate

“There are people who imagine or have this idea that somehow the FOMC should be making kind of global monetary policy,” Lockhart told Bloomberg Television on Aug. 23. “You have to remember that we are a legal creature of Congress and that we only have a mandate to concern ourselves with the interest of the United States.”

The concern abroad is that when the U.S. does begin tapering and then tightening monetary policy, capital will flee developing countries, forcing up local borrowing costs. Policy makers from India, Indonesia and Brazil were among those who raised interest rates or introduced currency-intervention programs to temper the impact on their markets of speculation the Fed was poised to trim aid.

The Fed’s influence was evident on Sept. 18, when its surprise decision not to pare its stimulus lifted the MSCI Emerging Markets Index to the highest since May. A group of the 20 most traded emerging-market currencies tumbled to the lowest since 2009 this month before rebounding.

Foreign Criticism

The latest worries are a reversal from the recent past, when Bernanke faced foreign criticism that his use of stimulus helped drive about $4 trillion into emerging economies, pushing up their currencies and threatening inflation. Yellen defended the Fed, saying last October that it’s not the “intention” of the U.S. to be difficult, yet “on balance, stronger U.S. growth is beneficial for the entire global economy.”

The Fed nonetheless needs to be alert to the risk of a “feedback” loop in which events abroad have a rebound effect on the U.S. economy if other countries weaken because of its policies, said Stanford University professor John B. Taylor.

“The Fed has focused more on domestic issues in recent years and that has caused problems globally,” said Taylor, a former U.S. Treasury undersecretary for international affairs. “The world is very integrated, and the notion the Fed can ignore the rest of the world is not viable. Taking more of a global viewpoint would be in the interest of the U.S.”

Emerging-Market Slowdown

Having lifted the world out of recession in 2009, key developing countries have slowed or faced domestic challenges. Chinese leaders are acting to defend their 7.5 percent growth target after two straight quarters of weakening activity. India is suffering an outbreak of inflation even amid the softest expansion since 2009, while Brazil is wrestling with price pressures and a slide in the real. IMF forecasts show the gap between developed- and emerging-market growth rates this year will remain close to the narrowest in a decade, at 3.8 percentage points.

At the margin, Yellen will be viewed by investors as positive for emerging-market assets because of her focus on the benefits of quantitative easing and keeping interest rates low for long and suppressing volatility, said Andrew Balls, head of European portfolio management at Pacific Investment Management Co. in London.

“If you can foresee an environment of a slower-moving Fed, then that is favorable for emerging markets,” he said.

Structural Change

The next Fed chairman also will witness a world economy coping with structural change, according to Barry Eichengreen, a professor at the University of California-Berkeley, where Yellen once taught. He argues that what he calls “international variables” again will influence the two indicators — inflation and unemployment — that the Fed is tasked with controlling.

Globalization will force the U.S. to become more open to trade and financial transactions, while emerging markets will eat into its share of the global economy even if they slow for now, in his view. More controversially, Eichengreen says the dollar will be challenged as the chief reserve currency, although that will occur over many years as the euro and yuan attract increasing demand.

The U.S. current-account deficit already has halved to about 3 percent of gross domestic product since 2005, while the IMF projects that by 2018, the U.S. will be responsible for 21.6 percent of global GDP, down from 30.8 percent in 2000.

China Growth

By 2027, China will have overtaken the U.S. as the largest economy in terms of market exchange rates and be more than 20 percent bigger by 2050, with India and Brazil also closing in, according to a January study by PriceWaterhouseCoopers LLP. The report estimated emerging markets will grow 4 percent a year from 2011 through the next four decades, almost double the U.S. pace.

“The biggest story in the global economy is the rise of Asia and other emerging markets,” said St. Louis Fed President James Bullard in a Sept. 20 interview. “So these are all factors that change the complexion of monetary-policy making in the U.S. over time.”

Paying attention overseas also is important because of the need to ensure financial stability when trouble in one country can be transmitted elsewhere through markets, according to Mark Gertler, who teaches economics at New York University. He sees central banks having to ensure common regulatory regimes or risk distorting capital.

“We live in a global world, and it’s important to account for that in policy,” said Gertler, who has written papers with Bernanke.

Too-Big-to-Fail Threat

The Financial Stability Board, the international banking regulator, currently is pushing nations to intensify efforts to end the so-called too-big-to-fail threat and share more information across borders so large banks can fold in a more orderly way than Lehman Brothers Holdings Inc. did in 2008. Policy makers also must complete talks on how banks manage risk and leverage.

Global forces have “repeatedly played a consequential role in the decision making” of the Fed, said Eichengreen, who wrote a paper entitled “Does the Fed Care About the Rest of the World?” for a July conference in Boston to mark the Fed’s centenary.

The central bank was founded partly because of the need to provide international markets with dollars to make it easier for U.S. exporters and financiers to win business abroad, said Eichengreen, a former IMF adviser.

Defend Gold

In the 1920s, the Fed sought to defend the gold standard and then responded to Britain’s 1931 exit by tightening monetary policy, putting exchange-rate stability over price and economic stability even amid the Great Depression, he said.

In the 1960s, the Fed paid attention to the U.S. balance of payments amid gold outflows -- sometimes leading policy to be tighter than inflation and the economy would suggest it should be, in Eichengreen’s calculations.

While he says international events have moved toward the edges of the Fed’s radar, other economists disagree.

The Fed loosened monetary policy in 1982 as Latin America’s debt crisis blew up and then again under Greenspan in 1998 as Asia and then Russia were roiled, even though the U.S. was midway through what would become a decade-long boom, according to Harvard University professor Jeffrey Frankel.

Policy Shift

“Even in recent years, the Fed has occasionally made a policy shift for international reasons,” said Frankel, a member of the Council of Economic Advisers under Yellen. “If there is a deep recession in Asia or elsewhere, it does affect us.”

Randall Kroszner, a Fed policy maker from 2006 to 2009 and now a professor at the University of Chicago, agrees the Fed has been forced to acknowledge and react to reverberations from abroad.

It united with fellow central banks in October 2008 to deliver a rare coordinated interest-rate cut and established and repeatedly augmented so-called currency swap lines with other monetary authorities to safeguard international access to dollars.

It assisted a 2011 intervention to restrain a surging yen and is involved in an international overhaul of banking regulation. The euro-area’s recent recession and the effects of Japan’s 2011 earthquake and tsunami also probably weighed on U.S. growth.

The Fed’s “been very engaged in international things,” Kroszner said. “The lesson of the crisis is it has to be. If a crisis starts, it has an enormous impact on the U.S.”

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