U.S. Federal Reserve Is Failing as World's Central Bank
There's a power vacuum in international monetary policy leadership, and the U.S., with an inactive Federal Reserve, isn't doing anything to fill it. Cash, then, might become yet more attractive to investors and portfolio managers.
That's the message coming from Mohamed El-Erian, the chief economic adviser to Allianz and chair of President Obama's Global Development Council.
Yesterday, El-Erian's opinion piece in the Financial Times titled "Divergence by Central Banks Makes Cash an Attractive Prospect" underscored this running theme: namely, that countries' monetary policies are closely intertwined, and that there is a vacuum in leadership. This is a gap that the U.S. could fill, but has not.
The world's major central banks diverge in monetary policies. The Federal Reserve System has been on the verge of raising its short-term policy rate for most of this year. The European Central Bank has been conducting a policy of quantitative easing since earlier this year and seems about to extend and expand this effort in December. The People's Bank of China has just lowered interest rates. Japan's central bank is still trying to get the Japanese economy going again. And so on.
El-Erian, also the former CEO and co-Chief Investment Officer at PIMCO, as well as the former president and CEO of the Harvard Management Company, the organization that manages Harvard's endowment and other accounts, suggests something else.
He writes: "Persistent policy divergence will be hard to maintain given the interconnectedness" of international financial markets.
What El-Erian is saying is that the interconnectedness of the world's financial markets is so substantial that it is difficult, if not impossible, for one country to conduct its monetary policy independently of what else is going on in the world.
So, in the current situation the "persistent policy divergence" that now seems to exist in the world will not be maintainable, he writes. This leaves the United States in a dilemma because of the "limits to U.S. willingness to allow its currency to carry the burden of the adjustment process."
"Either the Fed will have to reverse course as the U.S. economy is pressured by persistent weakness in Europe and the emerging world; or, a more comprehensive policy response out of Europe reinvigorates growth there, enabling the ECB to start its own policy normalization process," he writes.
That is, El-Erian is arguing that the U.S. and the Federal Reserve System must take on a responsibility more like the world's central bank, something it likes to do when the U.S. gets most of the benefits of its actions, or, act with a narrow focus just concentrating on its own narrow sovereign nation aims at other times.
If the United States and the Federal Reserve System acts just upon the narrow interests of the U.S., then the European Union and the ECB are going to have to assemble a coherent economic plan that gets European growth back to more normal levels.
The question is, "How much would you bet on the possibility of the members of the eurozone assembling a unified economic plan within the next five to ten years?"
Two things can be drawn from this.
First of all, the world is different now than it was when the post-World War II international financial system began. Perhaps the key assumption of this system was that international capital flows would be controlled so that every sovereign nation could pursue its own independent economic policy.
This lasted until the 1960s, and the spread of capital globally has only expanded and become freer since then. In the October meeting of the IMF in Lima, Peru, one participant exclaimed, "We have never seen something like this!"
This is unlikely to change.
Secondly, the world needs some kind of a central bank, and, the Federal Reserve System has come as close to playing this role as any institution, including the International Monetary Fund and the World Bank. Evidence of this comes from former Fed Chairman Ben Bernanke's new book, The Courage to Act.
The unfortunate thing on this point is that the world will not respond to this need until China becomes a bigger player in world financial circles, as it fully intends.
These two factors paint a picture of world financial markets continuing their volatility, with uncertainty neither disappearing nor lessening. Leadership seems to be absent.
El-Erian does not seem to have an optimistic view of the future. According to him, if the Federal Reserve does not "carry the burden of the adjustment process," or if Europe does not develop "a more comprehensive response," then the world will "tip into lower global growth and financial instability as weaker fundamentals undermine central banks' effectiveness in suppressing volatility and bolstering asset prices."
Cash may become a "more attractive prospect."
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.