TOKYO – Asian policymakers have a Jerome Powell dilemma on their hands. And it could be a bigger one than they realize.
Though the region has enormous stakes riding on US President Joe Biden’s policy mix, it’s Chairman Powell’s decisions at the Federal Reserve that will have the greatest impact on Asia in 2022 and beyond.
That is, assuming Powell gets another term as the globe’s most potent central banker.
Powell’s term expires in February and Biden is under growing pressure from Democratic Party progressives to name a more activist Fed head. That should worry a region that holds the most US dollars – the very same region that is most affected by excess US liquidity sloshing around the globe.
Aggressive easer, stable player
Powell’s aggressive easing in the Covid-19 era makes Chairman Ben Bernanke’s 2008 rescue efforts look modest.
Taking quantitative easing to new heights, Powell grew the Fed’s balance sheet past the $5 trillion mark, putting it in league with the Bank of Japan’s. The Fed topped that level in the first half of 2020 as Powell hoarded bonds and extended credit to banks, mutual funds and other central banks to stabilize world markets.
Luckily, markets have taken the Powell Fed’s ginormous asset purchases in stride and despite many expectations to the contrary, the dollar has held firm.
Yields on US 10-year bonds are just 1.3% and the Dow Jones Industrial Average is up a whopping 30% so far this year.
Yet markets abhor uncertainty. And Powell, for better or worse, may represent continuity for Asia.
At a time of great uncertainty, Powell is seen as “a steady hand,” says economist Derek Tang at advisory firm Monetary Policy Analytics. “The markets see him that way and that’s why it helps.”
The odds Biden would trade Powell for a more hawkish chairman are very low, Fed watchers say. Let’s hope so: The specter of an even more assertive Fed response to the Covid-19 era could quickly unnerve global investors and central bankers managing trillions of dollars of US Treasury debt holdings.
The extreme credit laxity of the last 13 years — and especially the last two years — needs skillful and mindful management. In a sense, the Fed is trying to pull off a magic act, a monetary sleight of hand. As it pushes into more and more asset classes, deeper and deeper, it’s trying to direct investors’ attention elsewhere.
The more punters gush over surging Wall Street shares, the less they are obsessing over the financial gravity that could drag markets down to earth at any moment. This includes a US public debt surging toward $30 trillion.
For evidence of this attitude, look no further than Japan, which is suddenly shopping for a new prime minister. Rather than fret the globe’s biggest debt-to-GDP burden and a BOJ out of ammunition, investors are entranced by the Nikkei Stock Average surging to 30-year highs.
US left’s anti-Powell agitation
Gripes about Powell’s tenure, which began in 2018, are coming from the Democratic Party’s left wing.
High-profile New York Congresswoman Alexandria Ocasio-Cortez and her ilk complain the Powell-era Fed hasn’t done enough about climate change. And that Powell, who comes from a banking background, is more attuned to the needs of financiers than low-income families.
Nobel laureate Joseph Stiglitz, a Democratic Party advisor, is also on the dump-Powell train. Stiglitz, who teaches at Columbia University, agrees that Powell’s monetary triage helped steady US growth in 2020. That includes aggressive monthly bond-buying programs Powell has maintained since March 2020.
“On the other hand, that is a bare minimum for qualification,” he says. “Almost anybody reasonable would have done something similar.”
Stiglitz thinks it’s an open question whether Powell is sufficiently committed to achieving full employment in the biggest economy. That might be particularly true, Stiglitz worries, should inflation pressure intensify.
Yet the inflation question is one that will bedevil Asian policymakers for some time.
There’s a valid question about whether Powell’s ultra-aggressive policies are already pushing America toward an inflation surge. One possible replacement whose name keeps coming up: Fed Governor Lael Brainard.
Yet a more activist Fed, at a moment of rising inflation pressures, could be more risk than solution.
The problem for Asia is that Powell, for all his flaws, might be the best option when it comes to the region’s interests. As permissive as Powell has been toward inflation, a replacement might be even less concerned about restoring “price stability” in the short-to-intermediate term.
Japan’s warning to America
There’s another risk here, one that runs through Tokyo’s experience these last 20 years.
A big side effect that spans the era of Bernanke – who ran the Fed from 2006 to 2014 – to the Powell era of today is how zero rates let elected officials off the hook. After the 2008 collapse of Lehman Brothers, the Bernanke Fed followed the BOJ down the QE road.
That muscular monetary response took the onus off US government leaders to remake the economy. Calls for then-President Barack Obama to re-engineer the tax code to enrich the middle class, not the 1%, lost momentum as Fed-driven growth returned.
The Fed’s largesse was grand for corporate profits. But those profits reduced the pressure on CEOs to raise their competitive games, rather than reveling in surging share prices.
Just like Japan.
Tokyo spent much of the 2000s working to weaken the yen. In 2012, then-prime minister Shinzo Abe came along and supersized the effort. He hired a new BOJ governor, Haruhiko Kuroda, to expand QE efforts and drive down the yen exchange rate by as much as 30%.
Trouble is, that deadened the urgency for Japan Inc. to resurrect its innovative spirits. It reduced pressure on companies like Sony Corp. and Toshiba Corp. to produce new products, raise productivity, cut costs or embrace meritocratic hiring and promotion norms.
BOJ largess, in other words, is leading Japan down a less vibrant path.
Economist Tan Kai Xian at Gavekal Research senses a similar dynamic at play in the US, as Fed splurges warp incentives. “US equities have gone almost 18 months without a double-digit drawdown,” Tan notes.
“Such calm,” Tan adds, “is likely to trouble devotees of Hyman Minsky, who showed that excessively long periods of market stability breeds countervailing episodes of violent instability. The question is what will cause the transition to a more volatile market – or dare I say it, what could trigger a ‘Minsky moment’” as the year unfolds?”
In the Fed’s defense, there was a good-faith effort to move beyond QE.
Powell’s pre-Covid prudence
In late 2015, then-Fed Chair Janet Yellen pulled off the first of several modest rates hikes. Powell would continue the campaign to normalize rates when he replaced Yellen in February 2018. The Powell Fed hit the brakes four times, much to the chagrin of Donald Trump, the president who hired him.
Powell returned the Fed to easing mode well before Covid-19 arrived. By the end of 2019, before “coronavirus” showed up in headlines, his team had reduced the benchmark rate to 1.75% from 2.5%.
Since then, the Powell Fed printed dollars with an abandon that in years past would’ve had Republicans screaming about “debasing the currency” and “banana republic” tactics.
Yet the force with post-Trump-era populism is stronger than economic orthodoxy among Republicans. Hence the irony that the most vocal critic of Biden-era policies – and by extension, Powell’s – is Lawrence Summers, a Clinton administration Treasury secretary and top Obama White House economist. Summers has “considerable concerns about inflation.”
Other liberal economists in Washington are less concerned.
“We have a Fed chair in Jerome Powell who has openly embraced full employment, one of the most important items on progressives’ agenda for many decades,” says Dean Baker at the Center for Economic and Policy Research think tank. “It is hard to imagine that we would not want to keep him there.”
The US Fed: Asia’s reserve bank?
Those concerns could soon be Asia’s nightmare if Powell’s confidence that the 5% inflation scares of recent months are transitory turn out to be wrong.
Any subsequent move to hit the brakes would push US yields sharply higher, causing an even bigger credit crunch than the 2013 “taper tantrum.”
The economic blows would be instantaneous. Aside from turmoil in markets, Asia would lose one of its two biggest destinations for goods and services. As the shockwaves head China’s way, it would generate massive headwinds for President Xi Jinping’s economy. Europe’s, too.
For more than 20 years now, the Fed has been the financial glue holding Asia together – and emerging markets, more broadly. In 1997, when Thailand’s devaluation set in motion the Asian financial crisis, the Alan Greenspan Fed jumped to action. Its assertive easing, and pledges to backstop Asian central banks, helped stabilize the region’s economies.
In 2008, Bernanke’s aggressive rate cuts helped stave off another Great Depression. The spillover effects from the Fed’s largesse helped Asia stay afloat in 1997, 2008 and more recently in 2020.
Despite efforts to wean East Asia off the dollar, the region is even more tethered to US Treasury debt today than ever. It holds more than $3.5 trillion worth.
As such, Asia has more riding on Powell, or whoever might replace him, than just about any other part of the globe.