Middle Israel: The limits of central banking

Is it possible that the current mayhem is about poor central banking?

amotz asa el 88 (photo credit: )
amotz asa el 88
(photo credit: )
The bad news these days is that a tornado is running through the world's financial markets threatening to affect every household in the developed world. But the good news is that the central-bankers, from Jerusalem to Washington, are on the case, this one siphoning hundreds of millions of dollars lest the greenback kneel, and that one uncorking billions of dollars lest a major investment bank fail, right? If only. If only the central-bankers' wands could command the markets the way Moses turned a staff into a serpent. CENTRAL BANKING was born in 17th-century Amsterdam, the result of an effort to instill order in a financial jungle that comprised no fewer than 800 different coins made up of assorted metals that hailed from competing private mints whose products were habitually forged, clipped and diluted. That is why the Dutch established a public bank that evaluated, converted and deposited coins in return for a modest commission. Eventually, central banks became money's producers as well as preservers of its value, supervisors of the commercial banks, and councils to their governments. Naturally, these tasks meant power, yet even so it would take centuries before governors of central banks would emerge as the celebrities, oracles, lightning rods and punching bags to which we have grown accustomed along the years. The first central-banker to become a major newsmaker was Paul Volker, who as Chairman of the Federal Reserve hiked US interest rates 20 percent and thus reduced US inflation from 13.5% to 3.2% within two years, to end the Carter-era stagflation. True, many found this potion bitter, including farmers who at one stage jammed Washington on tractors, but it ended America's worst economic crisis since the Great Depression, and Volker came to be celebrated as a gutsy expert who did the right thing at the right time. In Rome, the glory of the central-banker resulted last decade in the appointment of Carlo Azelio Ciampi as the clean-handed President of Italy in the aftermath of the country's worst-ever corruption crisis. In Israel, too, governor Jacob Frenkel became a major presence last decade as he resisted pressure from unionists, industrialists, merchants and politicians to weaken the shekel. Inflation's consequent decline to nearly zero serves until today as a telling reminder that the Promised Land, despite its sanctity, is still part of planet earth, and as such answerable to its laws of gravity, whether physical or financial. Still, no central banker was nearly as influential as Alan Greenspan, who headed the US Federal Reserve for nearly two decades, until his retirement a year-and-a-half ago. Now, with the dollar as weak as a sparrow, one wonders how Greenspan's governorship, illustrious though it was, relates to the mayhem that began, soon after his departure, in the US mortgage industry and has since proceeded to the equity, bonds and commodity markets, and this week even arrived at the doorstep of a venerable investment house like Bear Stearns. Is it possible that, just like previous economic salvations stemmed from sound central banking, the current mayhem is about poor central banking? GREENSPAN WAS a colorful character. A former jazz-band saxophonist who was among philosopher Ayn Rand's inner circle and married a glamorous TV journalist 20 years his junior, Greenspan's finest hour came shortly after his 1987 appointment, when he responded swiftly to the Dow Jones's 22% plunge in one day, so-called Black Monday. At a moment that begged analogies to the Great Crash, Greenspan avoided the 1929 Fed's ill-fated inaction, which back then resulted in America's money supply shrinking by one third within two years. Greenspan knew better, as he summarily cut interest rates drastically, from 7.5% to 6%, thus expanding the money circulating in the economy. Several weeks later the crisis was over. In the following years Greenspan kept the US economy vibrant and balanced, weathering storms like the Asian currency collapses of 1997, the following year's Russian debt crisis, the collapse of the LTCM hedge-fund the same year and then this decade's NASDAQ meltdown. Finally, Greenspan responded prudently to the September 11 attacks when he reduced rates gradually during that autumn from 3.5% to 1.75% - a 40-year low. Initially - it worked. The US economy survived September 11, and in fact proceeded to another protracted period of growth - until 2004. At that point Greenspan arguably failed in the central banker's most fundamental duty, which is to detect and offset economic trends when they bud. Yet Greenspan continued to reduce rates that year, all the way to 1%. Chronologically, this is what preceded the crisis in the US mortgage market, where penniless borrowers met heartless lenders, and that in turn preceded Bear Stearns collapse, all of which came while all commodities were surging and the dollar was melting. It is therefore arguable that at that stage the central banker's task was to cease caring about the traumas of 2001 and treat instead the euphoria of 2004, and that in turn would have meant raising rates, thus making it more difficult for those lenders to get their own funding as cheaply as they did. What's clear is that by the time Greenspan finally reversed course and raised interest rates - the horses had fled the stable. Now, as Greenspan's successor Ben Bernanke fights to control the damage, by cutting interest rates, and helping J.P. Morgan buy Bear Stearns at a fire-sale price, the question inevitably arises: Have Greenspan's unprecedented five terms been one too many? And should one mistake in its twilight blemish the illustrious career that preceded it? Perhaps, but history might also indicate that at stake were much larger things; that the dollar's continued slide was not about central banking but about imperial decline; that Greenspan was being expected to fight tsunami waves that were beyond his assignment and equipment; that the real task was for the statesmen to notice that newly rising economic powers would thirst for oil and wheat - and provide them; that the failure of the Fed's dumping into the financial markets of funds more than two times the entire Israeli GDP means the monetary artillery is not relevant for this war; that America's war effort could not be financed by excessive borrowing; and that the chaos in American housing - the market where the crisis began and where, according to Greenspan, it will also end - was but an extension of the dereliction of an administration that ran large deficits. In fact, we may soon learn that the global recession which began in 2007 marked the limits of monetarism, and exposed the unbearable inadequacy of fine central banking once challenged by poor statesmanship.