Bankers In the Crucible

By Robert J. Samuelson
Monday, December 22, 2008

They're technocrats, schooled in subjects that bore most people. They are appointed -- not elected -- to top government jobs, and what they do is not well understood. But they are enormously powerful, and, in 2009, they may determine whether the global economy avoids calamity. "They" are central bankers: Ben Bernanke of the U.S. Federal Reserve; Jean-Claude Trichet of the European Central Bank (ECB); Masaaki Shirakawa of the Bank of Japan; and their counterparts in China, India, Brazil, Mexico and elsewhere.

Not since the early 1980s, when high inflation plagued many advanced economies, or perhaps the 1930s, has their role been so crucial. Global economic expansion is slowing to a standstill. Economists at Deutsche Bank forecast meager 0.2 percent growth in 2009 -- the worst year since at least 1980. In 2007, world growth was almost 5 percent. Without stronger growth, the slump might feed on itself and fuel economic nationalism.

Superficially, central bankers seemed poised to deliver a revival. As if on cue, major central banks cut interest rates in November and December to spur growth and prop up their financial systems. The ECB reduced its key rate to 2.5 percent; the Bank of England went down to 2 percent, equaling the lowest rate since its founding in 1694; and many other central banks also cut rates -- China, India, Canada. As for the Fed, it has cut its key short-term rate from 5.25 percent in September 2007 to -- last week -- a range of zero to 0.25 percent.

With short-term rates so low, the Fed has embarked on a strategy of trying to reduce long-term interest rates by directly purchasing bonds and other securities that had been off-limits. Before the crisis, the Fed altered short-term interest rates in the hope that long-term rates on home mortgages and bonds would follow. Now, it has already announced that it may buy hundreds of billions of securities backed by mortgages and credit card, auto and small-business loans.

All this bespeaks the new aggressiveness of central banks. Until recently, there was little unanimity of purpose. In July, the ECB raised its key rate to 4.25 percent to prevent soaring oil prices from increasing overall inflation. "Europe was in denial" about the crisis until Lehman's bankruptcy on Sept. 15, says Fred Bergsten of the Peterson Institute for International Economics. But Lehman's failure -- and a parallel fall of oil prices -- changed attitudes.

In a crisis, history counsels cooperation. Its absence in the 1930s was disastrous. Consider the bankruptcy in May 1931 of Creditanstalt, then Austria's largest bank. That failure might have been prevented if Germany and France had agreed on a rescue package. They couldn't. Bank panics "spread to Hungary, Poland, Germany and Britain -- and the rest of the world," says Harvard political scientist Jeffry Frieden.

Massive "swap" lines between the Fed and 14 other government central banks represent one sign of today's cooperation. These swaps provide other central banks with dollars, which then can be lent to local banks. Companies, investors and banks in Europe, Asia and Latin America have borrowed huge amounts in dollars. As U.S. credit markets seized up, renewing their dollar loans became harder. The Fed's swaps -- roughly $500 billion in recent weeks -- substitute for scarce private credits, minimizing defaults.

It also seems encouraging that central bank cooperation reflects a broader political consensus. After meeting in November, the G-20 nations (the United States, the European Union, Japan, China, India and some other major countries) issued a statement forsaking protection and pledging parallel "economic stimulus" programs. Globalism, not nationalism. So far, then, so good?

Well, maybe. As Frieden points out, much of today's "cooperation" is through press releases. Countries agree on broad principles but then go their separate ways. Germany's "stimulus" program, for instance, is much smaller than the one apparently planned by the Obama administration. Countries renounce protectionism, but there are signs that China -- with a massive trade surplus -- might relax its policy of currency appreciation. By making the yuan cheaper, China would give its exports an added price advantage. If the United States inserted "Buy American" provisions in any stimulus legislation, it, too, would be embracing economic nationalism.

The dangers compound the pressures on central banks to restore economic growth. There is not so much cooperation among them as shared fears grounded in widely accepted scholarly conclusions about the Great Depression of the 1930s. Government blunders, it is widely believed, worsened the slump. Lessons seem plain: Don't let panic destroy the financial system; public lenders must advance when private lenders retreat. These responses seem plausible but prompt troubling question: What if this downturn is following a different script and defeats central banks' aggressiveness?

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