Memories of the Federal Reserve’s stringent 1994 cycle still trigger financial PTSD here in Asia.
Under the direction of then-chairman Alan Greenspan, the Fed doubled short-term interest rates in just 12 months. The brutality of the moves caused some serious collateral damage: Mexico’s economic downturn; bankruptcy of Orange County, California; 129-year-old bond dealer Kidder, Peabody & Co. dies; and developing Asia.
It took a few years, but the dollar’s powerful rally in response to higher US rates made it impossible to maintain currency pegs in Bangkok, Jakarta and Seoul. The resulting devaluation in 1997 put the region decades behind in terms of standard of living and economic confidence.
Now, the Jerome Powell-led Fed is poised to overtake the worst of the Greenspan era. Not because of the magnitude of the rate hike team powell Engineer may be, but how far behind the inflation curve it has fallen.
In 1994 and 1995, Asia had to figure out how to accommodate the large drop in US liquidity and the resulting yield spikes in the world’s most important debt market. Today, Asia must be prepared for this and there is a high probability that inflation in the largest economy will remain high for years to come.
Powell must own up to the extent to which Asia is losing faith in his leadership – and, by extension, the US economy. Under his leadership, the Fed made at least two serious mistakes.
First, to heed former President Donald Trump’s demands to lower US borrowing costs. When Trump named him Fed leader, Powell inherited a central bank on his way to normalize monetary policy, After the Lehman Brothers Crisis, Predecessor Janet Yellen was turning rates away from zero at the end of 2015.
When Powell took the reins in February 2018, he continued Yellen’s rate hike cycle. That is, until the Fed took out Trump’s anger. On Twitter and in speeches, Trump demanded that the Fed cut rates despite a solid US economy. And despite a massive $1.8 trillion tax cut at the end of 2017, the economy didn’t need a huge dose of fiscal stimulus.
Powell bound to tarnish the Fed’s credibility as an independent institution. Unnecessarily easing steps wasted ammunition the Fed could have deployed early in the Covid-19 crisis to avoid going too far down the quantitative-easing rabbit hole.
Mistake No. 2 in the inflation-temporal argument coming from American politicians in 2021 was too hard. In defense of officials like Yellen, who is now the US Treasury secretary, it was actually possible 12 months ago to think that supply-side forces raising prices may prove to be temporary.
That bet rested on the US taking steps to increase productivity, something President Joe Biden hoped his proposed infrastructure package would do. It was also not necessary that Russia’s invasion of Ukraine was coming. The resulting increase in the cost of energy, goods and food ensure inflation is a permanent phenomenon.
The gross failure by Saudi Arabia and other Organization members of the Petroleum Exporting Countries to increase production deserves some blame. But posterity may be even more stoked for glacial recognition at Fed headquarters that the action was taken as late as mid-2021.
What Greenspan and Paul Volker understood before them is that central banking is a confidence game. The reason the 25 basis-point tweak in credit terms has had such an impact is because “multiplier effect“Banks around the world are acting accordingly. The basis of that dynamic is the belief that the Fed is “on top of things.”
By misreading global risks, and forgetting the fundamentals, at the worst possible times, the Fed will spend years struggling to rebuild credibility. It should do so even in an era when the People’s Bank of China is spreading wings, and even beating the Fed by a huge margin in rolling out a digital currency.
It’s one thing for Fed critics Lawrence Summers, former Treasury secretary, to speak up. Or for former Fed governor William Dudley to warn “the risk of a hard landing is increased.” Losing faith is totally different for Washington’s top financiers.
Japan and China together have more than $2.2 trillion in US Treasuries. Add to other in Asia region biggest dollar holder And that figure is almost double that amount. In years past, Asian governments hoarded dollars because there was no safer or more liquid place to park mountains of state money.
Powell The more the Fed allows inflation to get out of control, the more it is doing Beijing’s work for it. A top goal for Chinese President Xi Jinping is to make the yuan the world’s reserve currency. This lobbying effort is becoming easier as the Fed forgets its role as the financial adult in the room.
Credit: www.forbes.com /