Fed Credibility?

On Thursday, Donald Kohn, Vice-Chairman of the Board of Governors of the Federal Reserve System gave a speech at the International Research Forum on Monetary Policy in Frankfurt, Germany. In that speech, Mr. Kohn spoke about “Global Economic Integration and Decoupling.” Decoupling, according to Kohn, “refers to apparent divergences in economic performance among different regions of the world economy.”

In this speech, Kohn referenced three different aspects of this decoupling:

1. The business cycles of the United States and other industrial economies are becoming less synchronized…

2. Economic growth in the emerging market economies is holding up, even as growth slows substantially in the United States and, to a lesser extent, elsewhere in the industrial world.

3. Even as the financial markets of many industrial countries have been roiled by turmoil that emerged last August, conditions in the traditionally volatile financial markets of emerging market economies have proved surprisingly resilient.

To me, this speech misses the point and represents one of the major reasons why the Federal Reserve and the leaders of the Federal Reserve are facing a real crisis of credibility. (See my June 23, 2008 post on “Credibility.”) The Federal Reserve is ignoring any role it has played in the decline in the value of the dollar over the past six years and the dislocations in world markets that this has caused. By continuing to ignore the role, it has played in the decline in the value of the dollar it is undermining any remaining trust that might exist in its leadership.

The Fed is also ignoring the role it is playing in the current financial turmoil. Concern over the behavior of the Federal Reserve is being expressed around the world. See, for example, the editorial comment in the Wall Street Journal, “The Fed at Ease," Also see the editorial comment in the Financial Times, “Fed cannot ignore global inflation." Yet, policymakers in the United States appear to be turning their eyes elsewhere.

The Federal Reserve Open Market Committee met on Tuesday. It presented the results of that meeting Tuesday afternoon and the statement made was, if anything bland and tepid. Basically, the statement said that we really aren’t in the mood to do anything at this time.

That certainly was a confidence builder!

This Federal Reserve leadership has introduced more innovation into the world monetary system than any before it. It has broadened the scope of financial oversight tremendously, even assisting in the Bear Stearns takeover, and is seeking more and more responsibilities. It is now looking at opening up the banking sector to private equity investment.

We are walking in new territory that has never been explored before. For example, we don’t know what all the innovations mean for the future. We have been told that many of the actions taken will be removed in the future when the need for them recedes. Yet we see that there exists $150 billion in Term Auction Credit outstanding, $64 billion in “Other Credit Extensions” which includes swaps to central banks in Europe, $8.5 billion credit extension on the “Primary dealer credit facility” and $111 billion in securities lent to dealers in through the “term facility” window. What do all these billions mean for the financial institutions and financial markets? How will they be removed?

We don’t know what these innovations mean. We have nothing to compare them to! In addition, then we seem to have leaders that are doing little or nothing to help their credibility in world financial circles! Where should the confidence come from?

Let me just say, that if this attention on the credibility of Fed leadership is getting into the newspapers then we need to be concerned. In my experience, newspapers tend to be a lagging indicator of how participants in the market feel. If the newspapers are expressing concern over the credibility of the leadership of the Federal Reserve, then the rest of the world must be really concerned!

Comments

[chrism1962]

The FED is seen to having a differing view from the rest of the world central banks. Effectively they are exporting inflation to the rest of the world by weakening the dollar.

The sovereign wealth funds and central banks have intimated that if the FED reduces interest rates, or weakens the dollar again, that they will stop buying T Bills Etc.

The ECB will raise interest rates to 4.25% this week (unless the FED tries to bring undue pressure to bear), which will weaken the dollar and probably cause the oil price to reach $150 pb.

It would be in everybody's interest for the FED to raise their rates by 0.25% to match the ECB rise, whereby the oil price would remain at around $140 pb.

The Qtr point rise in interest rates will hurt industry, and especially financials, but in the long term it should prove to be more beneficial to the overall world economy, if all central banks act with the same strategy.

The Bank for International Settlements meeting in Switzerland this week, may be stormy, hopefully a new consensus will be forthcoming.

[bruin532]

The ECB fearing further impact on the dollar and receiving conficting requests from the member nations on inflation vs growth will do nothing. If the dollar and the American stock market plunged post ECB meeting they would be left with perceived resposibility. NO CHANGE

[TN hick]

the FED's role, it seems, is to protect the "[investment] banks" at any cost; by buying time and depreciating the cost of the losses via inflation

[Mase]

The magazine the Economist, the issue out this weekend, also has an editorial comment on Federal Reserve credibility.

[carey_jim]

The leaders of the "free world" (the US Plutocracy) think they can use socialistic smoke and mirrors to make the American economy function according to their wishes.

After three generations of demonizing Communist China, the Soviet Union, Cuba, North Korea, .... one would think they have learned a lesson.

Maybe it wasn't about freedom and free markets after all, but maintaining their own power.

Why are they so blind now to the virtues of the free market, when it is so necessary to recognize them and ALLOW THEM TO FUNCTION?

[iThinkBig]

All good points. The Fed's plan in February was to prevent systemic banking collapse, even though it was understood it would create moral hazard. For now, it worked. The second part of the Fed's plan was to address 'inflation' which it stated it would do the latter part of this year. How many business people here? Is it the 3rd quarter yet, or the latter part of the year?!?! Fed will raise rates in August, .25%. I wrote this into my memo back in March. Now, the bigger issues of goverment become oligarchy and disconnected from it's people that can throw them out of power when the pain reaches a crescendo well, that is another story.