As politics fails, will central banks step back
James Saft is a Reuters columnist. The opinions expressed are his own.
HUNTSVILLE, Ala, — We’ve grown accustomed to central banks swooping to the rescue when events overtake governments’ ability to address economic and market fractures.
There are good reasons to wonder if that era may be coming to an end.
In the past week both the Federal Reserve and European Central Bank have come under intense pressure to act; the Fed from a slowing economy and steep market sell-off and the ECB from a buyers strike on Italian and other euro zone bonds.
Both chose to intervene. The Fed moved to keep interest rates at virtually zero until 2013, while the ECB, in a change in its recent tactics, once again waded into bond markets to buy up and support peripheral euro zone government debt.
Both, however, acted despite serious internal divisions over the policies, and more importantly, against a backdrop of political disagreement and discord that must threaten the central banks’ ability and resolve to take further steps.
“We have had a gathering crisis of political economy this year, which is partly about economic growth and jobs, but also and importantly, about a malaise in politics and policymaking, in which governments are seen as unwilling, unable, divided or ineffective when it comes to economic management and stability,” George Magnus, a senior economic adviser to UBS, wrote in a note to clients. ”
“It’s this resistance or backlash against the political order that runs through the propagation of the political economy convulsions around the world, including, in extremis, the uprisings through North Africa and the Middle East.”
Within the Fed the dissension is intense, with three voting members raising their hands against the policy. Charles Plosser, of the Philadelphia Federal Reserve, said on Wednesday that he thought the Fed would have to raise rates before its pledged 2013 date, comments that in themselves tend to undermine the effectiveness of the policy.
Richard Fisher, of the Dallas Federal Reserve, stood against the policy on the grounds that it is misplaced, as it does nothing to address political and regulatory uncertainty, and because it may give investors the impression that the Fed will nanny them by easing when they suffer losses.
Fisher was wrong about the economy; its prime problem is weak demand due to debt overhang rather than a sit-down strike by job creators vexed by Washington’s dysfunction and interference. More broadly though he is right; politics and monetary policy in the United States are now in conflict, a dangerous state.
It was another Texan, however, who made the most striking intervention — the state’s governor and newly minted Republican presidential candidate, Rick Perry, who launched an egregious attack on Fed Chairman Ben Bernanke.
“Printing more money to play politics at this particular time in American history is almost treacherous — or treasonous in my opinion,” Perry said when asked about the possibility of further easing by the Fed ahead of next year’s election.
He added, “I don’t know what y’all would do to him in Iowa, but we would treat him pretty ugly down in Texas.”
That an apparently viable candidate for a major party would stoop to such bullying is all the evidence you need of the vicious riptide the Fed faces. It also, by the way, amply justifies Standard & Poor’s downgrade of the United States on the basis of political dysfunction alone.
Don’t be mistaken; QE2 didn’t really work and QE3 probably won’t either.
To be clear, quantitative easing does raise legitimate issues over the separation of powers. It veers close to being fiscal stimulus by another name, and as such is particularly sensitive when there is discord over fiscal policy among elected politicians.
Will the Fed risk its birthright of independence in order to keep more Americans off of the soup lines? You have to wonder. Perhaps Perry’s attack will give it resolve, but perhaps not.
As for the ECB, its position isn’t going to get any easier soon. It hates buying bonds and propping up government finances, but does so probably because it fears a financial market cascade that could tear apart the euro zone.
The ECB would dearly love to be taken out of the process, but for that to happen, Germany, France and their partners must agree to increase the size of the European Financial Stability Fund or agree to sell Euro Bonds, a means for weaker nations to borrow at a better rate by sharing a guarantee with the strong.
Both of those moves are steps along the road to fiscal union, and as such very politically divisive and not likely to happen immediately. The ECB will probably continue to act when needed, but in doing it they will eventually close off options for its elected colleagues.
The risk that at some critical point the ECB balks must be rising.
This uncertainty over central bank intervention is a big part of the reason we’ve seen such volatility in markets. It’s an uncertainty that will be with us for quite a while.
At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.