Crisis Management

Welcome to the Fed, Janet Yellen. Now, can you please save a global economy teetering on the brink of collapse?

The U.S. government is careening towards what might be an epic financial implosion, and Washington is gripped in yet another frenzy of high-drama. By contrast, the nomination of Janet Yellen to be the next chair of the Federal Reserve is anything but dramatic, and certainly more calming to frayed financial market nerves than Larry Summers would have been.

Beyond the glass ceiling implications of Yellen being the first woman to serve in that post, however, what should we make of this coming transition?

The prominence of the Fed has grown enormously over the last decades, starting with Paul Volcker, accelerating with Alan Greenspan, and continuing with Ben Bernanke. Perhaps because the Fed is independent and separate from party interests, it has acted as a steward of the financial system, and such attitudes are rare in the world of partisan politics. Critics -- and they are legion, vociferous, and mad as hell -- believe that the Fed is burdened with arrogance and has made precisely the wrong long-term decisions in a desperate attempt to stave off the crises that are an inevitable and healthy part of a free-market system. The Fed bankers themselves believe that they have kept the proverbial lights on in the face of political malfeasance and waves of global change. Yellen will do nothing to heal that split, and given her background is likely to see it widen.

Yellen has served as the Federal Reserve's vice-chairman since 2010, was a governor of the bank during the Clinton administration, served as Clinton's chair of the Council of Economic Advisers, and began her career as a staff member of the bank's research division in the 1970s. She worked her way through the ranks at the Fed, and would be the first head of the bank to have a resume largely built on serving that institution. She has impeccable academic credentials, with a Ph.D. in economics from Yale and a brief stint as a professor at Harvard. She is married to the Nobel Prize-winning economist George Akerlof, and has spent many years focused on employment, wages, and labor patterns.

Though she has accumulated respect within the worlds of academia and banking, she is not without critics -- hardly surprising given a multi-decade career in the upper echelons of policymaking. Indeed, it would be more surprising if she had no critics. Some have questioned her managerial style, while others have praised it, making it all but impossible to parse unless you know her.

The most telling criticism came during her confirmation hearings to be vice-chair. Because she was president of the San Francisco Fed during the housing bubble, some senators, including Republican Richard Shelby of Alabama, questioned how she could have allowed such egregious lending standards and loose credit. Yet, as a recent story in Bloomberg noted, in 2007, she was one of the first inside voices on the committee to express serious concern that housing prices were overinflated and heading for a fall with serous ripple effects throughout the economy.

Assuming she is confirmed, and that seems to be an extremely safe assumption, she will face a situation every bit as unenviable as the one that confronted her predecessor Ben Bernanke when he took the job. The best response so far to her nomination came from a tweet by former Obama speechwriter Jon Lovett, who quipped, "We finally get a woman to chair the Fed and what happens? Bunch of men try to destroy the monetary system before she can even start the job."

Yellen would not assume the position until January 2014, and by then, the drama over the debt ceiling and levels of funding for the U.S. government will have been resolved, one way or another. It's certainly in the realm of the conceivable that the morass over the debt will lead to sharply higher interest rates, and that would be an added item to an already full plate for Yellen. While she will likely not have to clean up the mess of a default or delay of U.S debt obligations, she will still confront an array of choices that revolve around when to taper Fed purchases of government bonds, how aggressive the bank should be as a lender last resort, and what to do if worst fears come to pass and the U.S government proves unable to prioritize payments in order to pay interests on its outstanding bonds.

Bernanke also was plunged into a crisis, and he responded with an aggressive policy of zero interest rates, easy access for banks to borrow from the Fed's coffers, and quantitative easing that has seen the Fed purchase $85 billion of securities a month and its balance sheet expand to more than $3 trillion. Those moves have been forcefully supported by Yellen, and may even have been policies that originated with her (absent microphones and transcripts, which only the NSA could conceivably provide, we will never fully know). She will now bear the responsibility of unwinding those purchases, and while many fear the possible effects that will have on markets, rates, and the global flow of money, no one knows what the consequences will be.

The optimal outcome will be a gradual rebalancing of global accounts, done slowly and deliberately over the course of years. The problem is that reality does not always present policymakers with optimal conditions. The bank has been adept under Bernanke in responding to crises, as have the other major central banks around the world. That is not a statement without controversy. A considerable chorus believes that central banks have critically wounded the free market and only forestalled the inevitable crash and crisis borne of years of ill-advised government monetary and fiscal policies worldwide. Many investors believe that whatever strength there has been in equities and whatever calm there has been in global bond and financing markets is a product of deeply misguided Fed policies, and that we are nearing a break point.

The Tea Party certainly believes that, and prefers to get the implosion over with now rather than later. Better a crash triggered deliberately than one that sneaks up on you, they argue. Yellen would not agree. She strongly believes that monetary and fiscal policies need to be supportive of the weak American economy and lousy labor market. She will not gain any allies in the Tea Party caucus, nor will she likely be on the Pauls' Christmas card list.

More than most Fed chairs, she is acutely sensitive to the labor market. Of course, one can question how much Fed policy can directly impact the labor market: The "dual mandate" of the Fed to promote "stable prices" and "maximum employment" only dates back to 1977, and the levers of money flow seem to have only an elliptical effect on whether companies hire. That flies in the face of macro-economic theory and policy, which holds that lack of credit or access to capital is one reason companies don't hire and one reason they fire. But in a world of enhanced productivity generated by robotics and information technology, companies often choose to invest not in people but in software systems or robots. There ain't much the Fed can do about such trends, nor would it prudent to try.

Yellen is the ultimate technocrat, and that is both a genuine strength and a possible weakness. The appeal of Larry Summers was that he was unpredictable and unbeholden to economic orthodoxies that he felt congenitally driven to question. But he lacked support and has a knack for making enemies. The world of macro-economic policy has become immensely complex, and technocratic knowledge is a necessity. Nonetheless, it is still a system of rules created by people. Economics and banking may be seen as a science, and economies perceived as mechanical systems in need of tuning and fixing, but in truth, they are fluid, ever-evolving systems that demand new responses to evolving circumstances. The Fed has acted creatively in recent years, and no one quite knows whether its policies will be a long-term success. The virtue of Yellen is that she shares responsibility for these innovative policies of quantitative easing. The unknown is whether she will be adept at how to alter that path if circumstances warrant.

Finally, in a world that is increasingly knit together by money, the Fed is a vital actor, but it is by no means the only actor or the most important. There is no one institution that shapes everything or most things. We live in a lattice of institutions where government has far less control, and where quasi-governmental institutions such as the Federal Reserve pull only a few select levers. Yellen may prove adept, or not, but her successes or failures will be one segment of a puzzle whose picture we don't even know. She is today's story and will be tomorrow's Fed chair, but navigating the shoals of a morphing global economy will be left to all of us.



Mind Your Own Business

Why America needs to fix its problems at home before messing around in Asia.

Leading a responsible nation requires delicate balancing. U.S. President Barack Obama must manage the time he spends on domestic and international politics, so he doesn't neglect thorny national issues, or overlook international situations where the United States claims to desire to play an important role. When a nation's foreign policy is more assertive than its domestic policy, problems can arise. Back in November 2011, Obama told the Australian parliament that "In the Asia Pacific in the 21st century, the United States of America is all in." Clearly, he has both overstepped and not followed-up. But if Obama were able to balance this so-called "pivot" to Asia with domestic concerns, Asia-Pacific nations would welcome the United States as a responsible stakeholder in the region. Unfortunately, these days, that is not the case.

In early October of this year, Obama announced he would not be attending the Asia Pacific Economic Cooperation summit, the premier gathering of Asian leaders, held October 7-8 in Indonesia. This is not the first time Obama has failed to attend top gatherings of the region's leaders. Though he dispatched the capable John Kerry to attend on his behalf, the secretary of state lacks Obama's stature, and thus is less able to push the U.S. regional agenda.

Obama appears overwhelmed by domestic problems. He cancelled his Asia trip because of the U.S. government shutdown, which arose from his desire to defend "Obamacare," his controversial health care program. Promoting universal medical insurance has been part of his party's platform for over half a century; similar plans are already available in many industrialized countries. However, Obama may have failed to understand a fundamental tenet of American exceptionalism: The United States has a unique history and culture that allows its citizens great liberty -- and many believe that includes the right not to buy medical insurance.   

Republicans may deserve most of the blame for the government shutdown, but as president, Obama shoulders the ultimate responsibility for shaping the nation's agenda and forging consensus so the government does not fall apart. Obama has been pushing the right agenda, but at the wrong time: Obamacare shouldn't be prioritized until the United States is able to balance its budget and foster the growth of middle-class incomes.

Obama's Asia policy suffers from the same excess of ambition and lack of balancing as his healthcare policy. Washington has expressed concern about Chinese vessels conducting economic activity in several Southeast Asian nations' exclusive economic zones. And the White House worries about China's "assertive" handling of territorial disputes with U.S. allies, including the Diaoyu -- islands in the East China Sea which Japan claims -- and Huangyan, a shoal in the South China Sea claimed by the Philippines. By meddling with the Diaoyus, Obama is taking an unbalanced stance in favor of Japan, thus stirring up tensions in East Asia.

Despite the controversies that periodically flair up between China and Japan, both countries' willingness to shelve the long-standing dispute secured four decades of regional peace and stability, ever since the two countries normalized their relationship in 1972. However, by nationalizing the main islands in September 2012, Japan disturbed the status quo and forced China to respond. The United States could have checked its ally's incautious and irresponsible behavior. Instead, it encouraged Tokyo: In April, U.S. Defense Secretary Chuck Hagel said the Diaoyu "fall under" the Japan-U.S. Security Treaty, which requires the United States to defend Japan. 

In the South China Sea, if the United States wished to act responsibly it would be building regional consensus based on international law. Ensuring that all Asian nations honor the U.N Charter and the U.N. Convention on the Law of the Sea (UNCLOS), which legislates maritime behavior, would be a good start.  

But the United States has not succeeded in convincing Asia-Pacific nations that these international laws are crucial to their foreign policy. Vietnam, the Philippines, and Malaysia have all tacitly or explicitly admitted Beijing's sovereignty over the islands and islets within the South China Sea's nine-dashed line. However, these three countries have all seized some islands and islets on the Chinese side of the nine-dashed line. The United States has failed to fairly judge the dispute -- in fact, once again, it encourages these nations to contest Chinese claims. And even though the United States has not ratified the UNCLOS, it has asked China to allow that convention to govern its maritime behavior. If the United States were a responsible actor in the region, it would have ensured everyone plays by the same set of rules.

China is open to working with the Association of Southeast Asian Nations (ASEAN) to draw up and implement regional rules. In mid-September, China discussed with ASEAN nations a South China Sea Code of Conduct that would help reduce tensions and ensure responsible behavior. And in his keynote speech at the APEC summit, Chinese President Xi Jinping emphasized the importance of Asia-Pacific nations working together for their mutual benefit, and indicated a willingness to build regional consensus.

The United States pivot to Asia is not unwelcome -- but for it to be a responsible and sensible policy, it has to be a balanced one. Otherwise, U.S. action will not only be counterproductive, but too costly for a nation currently mired in a budgetary quandary. No one wants the United States to stay away from East Asia -- but if it can't manage the task, perhaps it should stay focused on the problems within its own borders.  

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