When Asians think about the “Powell Doctrine,” it’s 1990s US General Colin Powell’s preference for using overwhelming force that comes to mind. Asia now has a new one with which to contend: US Federal Reserve Governor Jerome Powell, who may be about to unleash the monetary equivalent of overwhelming force against inflation.
In his first outing as Fed leader last Tuesday, Powell opened the door to four interest-rate increases this year. He pointed to evidence that “the economy has strengthened since December,” a month before one of the biggest wage-spike scares in years.
There’s ample reason to think the Fed may have a hard time boosting borrowing costs as much as Powell might prefer. Japan demonstrates, for example, that central banks that go to zero have a very difficult time politically removing their monetary tentacles from a financial system that has grown dependent on them. The Powell Fed also might be on a collision course with US President Donald Trump, a leader who, like China’s Xi Jinping, bases his legitimacy on rapid growth.
But Powell is a complete wild card, partly because he’s not an economist. That means no paper trail of academic judgments to divine where his predilections lie.
As such, the market assumes that, for now, Powell will maintain the gradualist policies of the Fed under his predecessor Janet Yellen. He might not, if his team overreacts to any whiff of higher price pressures and the 2.9% jump in average hourly earnings in January. Also, might Powell’s thought process be mailable and susceptible to the more hawkish wing of policymakers?
Uncertainty emanating from Fed headquarters in Washington will keep Asian markets on edge. Sure, the region is enjoying rapid growth and buoyant equities bourses. But memories of the mid-1990s, a traumatic episode, loom large.
In 1994, the Fed led by Alan Greenspan embarked on an epic tightening cycle, increasing short-term rates by 300 basis points within a year. The resulting carnage killed securities giant Kidder Peabody, bankrupted Orange county, California, slammed Mexico and set Asia’s 1997 crisis in motion in ways the region should consider today.
Five years ago, at the height of the Fed “taper tantrum” that savaged emerging markets – India and Indonesia, included – South Korea’s central bank warned that the “ghost of 1994” might haunt Asia. That didn’t happen in 2013. But with tightening US labor markets, surging equities and Trump adding US$1.5 trillion of fiscal stimulus the economy didn’t need, the Powell doctrine could easily bring back shades of ’94.
Though Asia’s excessive borrowing and institutional weaknesses deserve blame, the dollar’s massive rally beginning in 1994 made currency pegs impossible to maintain. Thailand devalued first in July 1997 and the dominos fell from there. Dollar debt became even harder to service, overwhelming corporate sectors and sending Bangkok, Jakarta and Seoul scurrying to the International Monetary Fund for cash.
The chaos reached Russia, too, which defaulted in 1998. That, in turn, boomeranged back to Washington. The Fed scrambled to stem fallout from the failure of giant hedge fund Long-Term Capital Management. The resulting chaos added to pressure everywhere, including Asia.
China alone complicates decision-making for the Powell Fed, or at least it should. Xi Jinping wasn’t president in 2008 and 2009, but Beijing surely owes the Ben Bernanke Fed thanks for its assertive quantitative-easing problem. Titanic waves of liquidity from Washington stabilized world markets and helped China beat the odds. Beijing would have faced far bigger headwinds, Japan’s banks would have suffered bigger credit crunches and Indian growth might have come in markedly lower if not for Fed QE bailing out world markets.
Powell must avoid throwing Asia’s biggest economy off-balance, as well as the broader region. The question is, though, will he? Just in case, Asia should ready some fiscal and monetary responses for any signs of overwhelming forces in Washington.