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Sometimes it takes a woman to do a man's job
Publication Date : 16-10-2013
Janet Yellen, nominated as the next chair of the US Federal Reserve, will be responsible for weaning a weak patient off strong medicine; can she succeed?
In Chinese history, a woman's ascension to power is either a sign of profound change or dramatic crisis. Janet Yellen's nomination as chair of the US Federal Reserve is a sign of changing times. Note that both the Fed and the SEC will be headed by women. After all, Christine Lagarde, head of the IMF, has said that if Lehman Brothers had been a bit more Lehman Sisters, we would not have had the same degree of tragedy!
In essence, we need women to clean up manmade messes.
The difference here is not that Yellen is taking over in crisis, but is faced with withdrawing the medicine for the crisis. She inherits an intoxicated punch bowl, with a central bank that needs to unwind massive quantitative easing (QE), at the same time as the US faces its own debt debacle. According to the Congressional Budget Office, the US will run out of borrowing authority tomorrow and will have about US$30 billion in cash after that. The country would be unable to pay all of its bills, including benefits, salaries and interest, sometime between October 22 and 31.
The rest of the world sits aghast with disbelief that the most powerful economy in the world can have a debate whether the government will stop paying its bills, because some Tea Party members can play "who blinks first" with the president on changing the medicare legislation. This is a stark reminder that crisis is not about rationality and that politics is the real dismal science, not economics.
I have no doubt that in terms of IQ, EQ and experience, Janet Yellen is imminently qualified to be the captain of the world's leading central bank. As former president of the San Francisco Fed, she understands not only the issues of an open, innovative West Coast economy, but also the dynamic Pacific Rim countries that account for 55 per cent of world GDP and 44 per cent of world trade.
The Apec economies, being large users of the dollar for trade, and largest dollar holders in their foreign exchange reserves, have high hopes that the new Fed chair will protect the value of their dollar holdings.
What is the scorecard that Yellen has inherited?
"QE3" is committed to buying $85 billion worth of long-term Treasury paper, including $40 billion of mortgage-backed paper, per month, for as long as is necessary. Furthermore, since December 2012, the Fed has said it intends to hold the federal funds rate near zero, at least until unemployment has declined below 6.5 per cent.
As far as I know, there is no theoretically proven causal effect on low interest rates reversing the level of unemployment. Even current chair Ben Bernanke has admitted, "We don't have tools that are strong enough to solve the unemployment problem."
Despite this, the purpose of QE is to tell Congress that the Fed stands fully behind the economy, buying time for the real structural reforms to be undertaken by the politicians.
But that is exactly the unfortunate dilemma of modern central banking. By stepping forward with a printing solution in a policy vacuum, central banks gave their politicians the perfect excuse not to take the tough medicine of structural reforms. As former European Commissioner Jean-Claude Juncker honestly admitted, "We heads of government all know what to do; we just don't know how to get re-elected when we do it."
We all recognise that unconventional times needed unconventional tools. The Fed can be congratulated for taking decisive action in 2008 to prevent a financial meltdown. But applying a stimulant during a heart attack does not mean that you should apply it forever.
There are several good reasons why aggressive and prolonged easing can lead to negative results. First, by spraying everyone with liquidity, it is the banks and those able to borrow cheaply that benefit more than those who cannot access finance. This is a distributional issue that has huge political ramifications that will haunt future central bank independence.
Second, the low interest rates actually erode the income of pension funds and life insurance companies, thus worsening the net wealth of retirees - another distributional issue that explains why Republicans also do not like QE.
Third, prolonged low interest rates and high liquidity renewed incentives for a "search for yield" and another round of speculation and leveraging. Large carry trade capital flows rushed into emerging markets, and there was a huge gush out in May when Ben Bernanke started hinting about "tapering" QE. The latest IMF Global Financial Stability Report has warned, "After a prolonged period of strong portfolio inflows, emerging markets are facing a transition to more volatile external conditions and higher risk premiums. Some need to address financial and macro-economic vulnerabilities and bolster resilience."
Fourth, QE and low interest rates are atrophying market discipline. Central bank balance sheets are triple what they were before 2007. They have become front-line intermediaries in areas such as the mortgage market and money markets.
Indeed, governments with debt over 100 per cent of GDP are completely reliant on low interest rates to sustain their budget debt servicing at a reasonable level.
Even the august Bank for International Settlements has warned, "unusually accommodative and protracted monetary conditions can delay the necessary balance sheet repair and misallocate resources".
The financial markets and the governments are very happy that Yellen said in April that she is persuaded that "the policy rate should, under present conditions, be held 'lower for longer' than conventional policy rules imply", implying that she is a monetary dove.
But what may be needed in the near future is tough action to ensure that the US and the rest of the world do not enter into a period of stagflation - slow growth, high unemployment and inflation.
Now that's a real test of central banking skills. Good luck, Janet. We all wish you well.
Andrew Sheng is president of the Fung Global Institute.