by Avinash Persaud
Washington's economic leadership fails the test, says Avinash Persaud, chairman of the financial advisory firm Intelligence Capital.
Monetary and regulatory policy should be about reinforcing solid conduct in financial markets and punishing bad behaviour. But the rate cut from the United States Federal Reserve on 22 January does little of the sort.
By delivering a large rate cut one week before the scheduled 29-30 January policy meeting, just as attention was drawn to plummeting share prices, the Fed has once more given the impression that it is led by the equity markets.
This is an impression the Fed should have tried harder to avoid.
We are in this economic mess in the first place because financial markets previously lent and borrowed in an undisciplined manner, precisely because they thought the Fed would always come to their rescue.
And, if the markets were unsure as to whether the so-called "Greenspan put" existed, they are now convinced of the Bernanke one.
But puts are not free. The cost of the partial belief in the Greenspan put is today's market chaos and the knock-on effect onto the economy.
Could one argue here that bygones should be bygones? Surely, with the housing and equity markets collapsing, wasn't the Fed still right to slash rates?
The problem with that is that asymmetries matter. It simply does not work to be a stoic inflation targeter during a boom, refusing to raise rates until inflation actually rises, unmoved by asset market bubbles, but then swiftly turn into a wild banshee, pouncing on every threat of economic weakness. This is Jekyll & Hyde central banking. It will raise the incidence of booms and crashes and undermine disciplined borrowing, lending and investing.
Better for the Fed to be almost as activist in avoiding bubbles as it is in rescuing the economy from crashes. Or, if it does not wish to be so activist, for the central bank to hold to its inflation target, keep rates steady until inflation moderates and let automatic fiscal stabilisers share some of the burden of smoothing economic activity. A few central banks try to do just this, unhelped by the sharp swings in international rates and their associated swings in currencies.
But instead, real interest rates have once more been pushed to below zero. This will do the trick of bailing out the banks. Again. However, it will do little to restore confidence in the credit rationing and valuing process, the roots of the current malaise.
The approach to central banking in the United States since Paul Volcker, the Fed chairman between 1979 and 1987, has been one of trying to avoid upsetting the financial markets at all costs. But we cannot continue like this.
We need to return to the finest tradition of central banking, so well espoused by William McChesney Martin, another former Fed chair, in his 1955 speech to the New York branch of the Investment Bankers Association:
"In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects - if it did not it would be ineffective and futile. Those who have the task of making such policy don't expect you to applaud. The Federal Reserve, as one writer put it after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punchbowl removed just when the party was really warming up. But unless the business community, leaders in all walks, exhibit moderation, prudence, and understanding, then we will fail and deserve to fail."
A measure of that failure today is that since the turn of the century, real interest rates in the United States have been below zero for one third of the time. No business, investor or saver can plan for the long-term with that degree of monetary instability. We learned that in the 1970s. It is no surprise now that gold is scaling heights not seen since then.
