x Abu Dhabi, UAEMonday 22 January 2018

Gulf still waiting for US Fed chief to make right move

This week Barack Obama announced that he would reappoint Ben Bernanke, who was originally installed in 2006.

Let us now praise famous Ben, the Federal Reserve chairman who, in a nation where nearly one in 10 people is out of a job, has managed to keep his despite failing as banking tsar to prevent a financial crisis so severe that it plunged the US and the global economy into the worst recession since the Great Depression. This week Barack Obama announced that he would reappoint Ben Bernanke, who was originally installed in 2006 by the US president's predecessor and political rival, George W Bush, when Mr Bernanke's term ends next January.

This might seem like a quintessential example of what some call "failing up". Perhaps what it really underscores, though, is the tendency of investors, in this case the US government, to react to a losing trade by doubling down. Why, indeed, switch horses halfway through the race? Why not? Because Mr Bernanke has redeemed himself, according to some of the most respected economists around, by pulling the US and the global economy back from the brink of reprising the Great Depression. A student of the oil crisis and the Great Depression, Mr Bernanke for a while seemed destined to repeat the mistakes he had spent so long evaluating. For a long time as a Federal Reserve governor, he supported the leniency that led the US into this mess, keeping interest rates too low and failing to do anything about the dangerous expansion of subprime mortgages, and with it the explosive build-up of credit derivatives.

But then, drawing on the same deflation-phobia that in 2002 won him the moniker "Helicopter Ben", Mr Bernanke tossed the text books and began printing dollars to drop over the cash-starved American economy. The result of that impulse is the sharp rally in global stock and commodity markets we have seen in the past five months. Only a fool would mistake the rally for recovery, but it undoubtedly signals that Great Depression II has been narrowly, yet decisively, averted.

However well Mr Bernanke has performed for America, the question here is how Mr Bernanke has served the other nations that rely on him to set their monetary policies. For as long as the Gulf's currencies - Kuwait's excepted - are pegged to the US dollar, monetary policies in Riyadh, Abu Dhabi, Doha , Manama and Muscat are largely defined in Washington by Mr Bernanke. And if it were up to the Gulf, Mr Bernanke might have been out of a job about six months ago, if not earlier. Wind the clock back to spring of last year. The subprime crisis was already under way in the US, but the rest of the world was still booming. Inflation was rampant, particularly here in the Gulf, where oil prices seemed on their way to US$200 a barrel. Yet there was Mr Bernanke, cutting interest rates and stoking inflation here.

By June, even Mr Bernanke was convinced that inflation, not recession, was the big threat. He stopped cutting rates, and when he did, Gulf central banks also began a holding pattern. This is about when they might have fired Mr Bernanke and issued a pair of monetary policy objectives, revaluing their currencies and tightening the money supply. Some economists argue that rate hikes in the Gulf would have done little to mitigate inflation, due to supply bottlenecks. Nonetheless, higher interest rates relative to those in the US and an appreciating currency might have reduced the pain that the region, and the UAE in particular, underwent later.

It all went pear-shaped after that. In July, the US mortgage agencies Fannie Mae and Freddie Mac went down the tubes, forcing the government and the Fed to come to their rescue. The resulting liquidity crunch quickly spread around the globe. When Mr Bernanke should have been cutting rates to ease the cost of money, he wasn't. Inflation seemed to be abating thanks to steady rates. What didn't become clear until later was that inflation was easing not because rates had stopped falling but because demand for key commodities was collapsing. Oil prices, for example, crumbled, throwing most Gulf governments into deficit. Interest rates did not do this. The demise of the American consumer, and with her the Asian exporter, did.

Mr Bernanke should have been cutting to head off this collapse. The Gulf should have been raising rates relative to those in the US to ease inflation and prevent what then happened. Because by August, with global credit markets seizing up and investors convinced the Gulf wasn't going to revalue, vast sums of foreign capital fled the Gulf, creating a liquidity crunch that has yet to be resolved. Had the dirham already been revalued upwards and interest rates hiked, some of that money might have stayed put. Gulf central banks would have had more room to cut rates to ward off recession and the dirham could have fallen with oil prices, keeping oil revenues more or less constant in local-currency terms.

By September, when Lehman Brothers collapsed, the Central Bank had already started mimicking the Fed, injecting liquidity into the banking system, but it was too late to use a zero-interest-rate policy. Property prices were in a tailspin and it would have been a foolhardy banker to lend amid falling prices for collateral. Now we have come full circle - sort of. Thanks to massive new borrowing by the US government and a policy of buying US government bonds that results in the creation of more dollars, the US deficit is on track to reach $9 trillion (Dh33.05tn) over 10 years. That has since March sparked a rally in global stock and commodity markets as investors seek to hedge the risk that the burgeoning supply of dollars by an increasingly indebted government undermines the dollar's value.

The dollar's steady decline has torpedoed the largely dollar-denominated reserves of sovereign wealth funds and central banks, prompting consternation in the Gulf and howls of protest from Beijing. But Helicopter Ben is only warming up for his biggest challenge. Having prevented the demise of the world's largest economy, he must now wean it from a life-support system of monetary and fiscal stimulus. If he does it too quickly, the patient may relapse. If he does it too slowly, inflation may become entrenched.

Having failed to jettison him when it had the chance, the Gulf can only hope that Mr Bernanke's second whack at this goes better than his first. warnold@thenational.ae