/ 29 January 2010

Help wanted: Tough central bankers

Glenn Stevens, the governor of the Reserve Bank of Australia, is an accidental hero of the global financial crisis.

A career central banker, Stevens (52) once described himself in a newspaper article as “not a particularly great risk-taker”. On the day he was appointed to the job, August 1, 2006, the exasperated photographers crammed into his spartan office were forced to ask him to smile for the camera, according to local media reports.

“That’s a bit hard. I’m a central banker,” he deadpanned.

Then, on October 6 of last year, Stevens was thrust into the spotlight. Australia became the first G20 nation in the wake of the financial crisis to raise interest rates, signalling an upbeat view of future economic activity. It was not a widespread sentiment.

The surprise hike came as US and euro zone policymakers were still crossing their fingers, hoping their economies had escaped recession in the third quarter. It was hailed as a vote of confidence in a still uncertain recovery, pushing gold prices to a record high and global shares up nearly 2%.

In the end, Australia was among the few G20 nations to sidestep a brutish recession.

“We have long argued that Australia is the canary of the global economy,” RBC Capital Market senior economist Su-Lin Ong said at the time. “If the Australian economy kept singing, then it was likely the world economy would avoid falling into the abyss.”

It has not fallen so far.

Under ordinary circumstances, central bankers like Stevens aren’t major newsmakers in world affairs. But the combination of the financial nervous breakdown and the uneven economic recovery since has turned them into the equivalent of military generals waging a war. The question is whether, in the face of political opposition, they will deploy the weapons at their disposal.

Anyone doubting central bankers are in the hot seat need only look at the fix US Federal Reserve chief Ben Bernanke found himself in. Nominated by President Barack Obama for a second term, he had been widely expected to get the Senate support he needed when a surge of public anger at big banks and their bailout made the vote look a lot closer.

What Bernanke, who was expected to squeak by, and his fellow central bankers do from here on will likely have important implications not just for their individual countries but also for a $60-trillion global economy that is, for better or worse, becoming more financially inter-connected.

Chasing the debt dragon
The main challenge facing central banks is how to keep economic growth going without inflating the next bubble. Put starkly, that means jacking up interest rates from their current nonexistent levels, as Australia, Israel and Norway have now done.

It also means halting the spread of cheap money, which has turned out to be the financial equivalent of crack cocaine.

Weaning the world off the liquidity drug won’t be easy. The two most important economies, America and China, are moving at different paces, perfectly exemplifying the two-speed recovery that seems to be taking hold.

China and other emerging nations are zooming. The United States and Europe more or less remain stuck in neutral gear — and face rising unemployment and a potentially crushing debt burden.

Global financial markets have been further rattled by China’s moves to tighten policy settings — raising the amount of reserves banks must hold, for example — at the start of 2010. The fear is that this could impede the stubbornly weak global recovery and curb spending in one of the few nations with a surplus of savings — at the expense of countries like Australia.

That nation’s robust exports to commodities-hungry China is a chief reason the RBA could raise rates three times in a row in late 2009. By contrast, the US Federal Reserve, the Bank of England and the European Central Bank likely will remain hunkered down on the sidelines until the end of 2010, unable to boost rates.

The “lucky country”, as author Donald Horne once dubbed Australia, has made its own luck, mostly by allowing public coffers to fill with cash reserves during the previous decade of prosperity. That enabled the government to spend freely without building up debt during economic turmoil, helping to ensure a relatively easy run through the crisis.

Now for the hard part
Unlike Stevens, his counterparts at the US Federal Reserve chose not to prick any asset bubbles. As a result, the United States ran huge budget deficits before the financial crisis struck — and is now paying the price.

Eight months before Australia’s Stevens took office, Bernanke (56) assumed the US Fed’s helm in February 2006. He brought from his previous life in academia several strong convictions.

One was not using monetary policy to tackle asset price bubbles, arguing it is too blunt an instrument — an approach also taken by his predecessor, Alan Greenspan.

The consensus among economists and others is that the American central bank kept credit costs too low for too long. And that, most agree, helped lay the groundwork for the 2008 crunch.

Bernanke — who once joked that as chairperson of the Princeton Economics Department his major decisions included whether to order doughnuts or bagels for staff meetings — was criticised for his initially sluggish reaction to the crisis.

“The US let the housing bubble get out of control and paid a very heavy price for it,” said IHS chief economist Nariman Behravesh.

Though he suddenly finds himself facing a tough time in the Senate, Bernanke has won over some critics with his overall decisive response. A student of the Great Depression, he once famously told Milton Friedman that he was right to blame the Fed for aggravating the 1930s crisis through a lack of support for banks, and he was determined not to repeat the same mistakes.

In a Reuters poll in mid-2009, economists gave him very high marks — an eight out of 10 — for his performance during the past year, which was as difficult a year as a central banker can ever expect to meet.

But the hard part comes next.

And if Bernanke needs a reminder of what’s at stake, all he need do is visit his boyhood home in small-town Dillon, South Carolina. Last year its new owners joined the ranks of those who lost their homes to foreclosure, one of a record 2,8-million US homes to meet such a fate.

Debtors’ circle
How Stevens, Bernanke and their fellow central bankers grapple with three critical issues — runaway debt, looming inflation and new potential bubbles — will help determine the fate of the global economy over the next several years, if not beyond.

Fears that the world could plunge into another Great Depression prompted governments nearly everywhere to dig deep for emergency measures to bolster economic growth and shore up the banking sector.

Judging by the growing signs of recovery, their hyperactivity paid off — but at a potentially staggering price.

The International Monetary Fund projects government debt as a share of economic output in all advanced nations will soar as a result of the crisis, from 78% of GDP in 2007 to a whopping 118% in 2014. – Reuters