Wednesday, December 17, 2008

Fed reaches end of its traditional road

Business Times - 18 Dec 2008

From now, it may resort to other tools such as printing new money


PUNDITS have been using a variety of dramatic adjectives - 'rare', 'unprecedented', 'extraordinary', 'radical', 'historic' - to describe the Fed's decision on Tuesday to cut its target for the federal funds rate to a range of zero to 0.25 per cent - a record low - from one per cent.

But in a way, in a year that has seen so many 'rare', 'unprecedented', 'extraordinary', 'radical', and 'historic' moves by the US federal government, including the partial and complete nationalisation of several banks and investment houses and the bailing out of many financial institutions, not to mention the long list of fiscal and monetary policies, the decision by the central bank to slash its benchmark interest rate close to zero was not only expected but somewhat anti-climactic, especially when one takes into consideration that the effective Fed funds rate, which is based on actual banking transactions, has already dropped to zero a while ago.

Against the backdrop of new reports that pointed to more bad economic news, including a dramatic decline in home construction and continuing fall in consumer prices, the Fed stated that it was willing to keep rates low for a long period and that it would apply 'all available tools' to assist in the recovery of the US economy and prevent a long and devastating recession.

In practical terms, the central bank may have reached the end of the line as far as its traditional monetary policy is concerned. The Federal Open Market Committee (FOMC) will not be able to announce another set of cuts in its next meeting in January next year, just as the new president is about to enter the White House.

That means that from now on, Washington would have to begin pursuing a more unconventional course of action to contain the clear and present danger of deflation and a continuing economic slump through an unprecedented form of fiscal policy - the trillion dollars or more in government spending, aka a stimulus package, under the Obama Administration, with the Fed pumping credit into the market in the hope of helping to reduce the cost of borrowing for businesses and consumers.

Hence, the Fed is expected to embrace a tool of monetary policy known as 'quantitative easing', meaning that it will print new money in order to increase its supply.

That was basically the policy adopted by the Bank of Japan to deal with its domestic deflation at the start of the decade.

In fact, the Fed has already started pursuing this policy in the aftermath of the collapse of Lehman Brothers and it will take several months for its effect to be felt in the markets as the Fed buys more mortgage-backed and consumer debt.

Policymakers and economists continue to debate whether the policy of quantitative easing - with the Bank of Japan, it flooded commercial banks with excess liquidity to promote private lending - had its desired effect on the Japanese economy or whether it may have created disincentives for the needed economic reforms in Japan.

In any case, the current conditions of the American and global economies are very different from the one that existed in Japan in 1999.

The combination of a gigantic economic stimulus package in addition to other government expenditures, and the printing and pumping of more US dollars by the Fed is bound to increase the budget deficit to new heights and put enormous downward pressure on the US currency.

That means that even if the fiscal and monetary policies pursued by Washington could prevent a Great Depression II, they could end-up creating new long-term structural problems for the American economy.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.

Obama should take the other road to Jerusalem

Business Times - 17 Dec 2008


IN EARLY 2002, the then US secretary of state, Colin Powell, was exploring ways to restart negotiations between the Israelis and the Palestinians that had broken down in the aftermath of the second Palestinian Intifadah (uprising).

Mr Powell was arguing that a resolution of the conflict between Jews and Arabs in the Holy Land could help lessen anti-Americanism in the Arab world and restore US power in the Middle East which had been challenged on 9/11.

The notion that the road to a more stable and pro-Western Middle East leads through Jerusalem - the resolution of the Israeli-Palestinian conflict - was very much the accepted wisdom among members of the foreign policy establishment in Washington as well the view of most of US allies who called on President George W Bush to embrace a more activist US diplomatic approach in the Middle East.

But Vice-President Dick Cheney and Defense Secretary Donald Rumsfeld as well as the neoconservatives with influence on the administration's foreign policy insisted that the only way to re-establish the United States' dominant position in the Middle East was by ousting Iraqi leader Saddam Hussein, occupying Iraq and 'remaking' the Middle East.

'The road to Jerusalem leads through Baghdad,' argued the neocons, suggesting that the emergence of a democratic and pro-American government in Baghdad would have a domino effect on the rest of the Arab world, including the Palestinians who only then would be ready to make peace with Israel.

But the American military adventure in Iraq ended up creating more political instability and anti-Americanism in the Middle East while strengthening the power of Iran and its allies in Iraq and Lebanon. At the same time, the American-sponsored free elections in Palestine brought the radical Islamic movement Hamas into power. Hamas, unlike the secular Fatah, was opposed to making any peace with Israel. This made resolution of the Israeli-Palestinian conflict less likely and ignited more Palestinian-Israeli violence and led to an intra-Palestinian rift.

In fact, the mess in the Middle East that resulted from US policy created the conditions for the 2006 war between Israel and Hizbollah which further weakened US influence in the region and narrowed the chances for Israeli-Palestinian peace.

When Mr Bush's Freedom Agenda crashed into the reality of the election of Hamas in Palestine and the strengthening of the power of Iran, Mr Bush and his aides suggested that the Arab-Sunni states, including the moderate Palestinian leadership, and Israel form a 'strategic consensus' to contain Tehran; Washington then went through the motions of the peace process during the Annapolis Conference in 2007.

But if the road from Baghdad paved by Mr Bush and the neocons led to more wars and failed to reach Jerusalem, President-elect Barack Obama would have an opportunity to build a highway to Israeli-Palestinian peace. Mr Obama promised to reverse the Bush administration's policies in the Middle East by emphasising that the US war against terror is not part of a US-led war against Islam, by starting a dialogue with Iran (and Syria) and by trying to energise the peace process. Unfortunately, Benjamin Netanyahu, the nationalist Likud leader who most opinion polls predict will be elected as Israel's next prime minister in February 2009, has said that he was only open to the idea of 'economic peace' with the Palestinians.

This would amount to another neoconservative-Likud pipe dream: Placing a political settlement of the Israeli-Palestinian conflict on the policy backburner as America - pressed by Israel and its supporters in Washington - deals with the Iranian nuclear issue. Mr Netanyahu will argue that only a military defeat of Iran and its allies would provide the right conditions for resolving the Israeli-Palestinian conflict. As the neocons now say: 'The road to Jerusalem leads through Tehran.'

Mr Obama will need to challenge those Israelis and Arabs who want to maintain the status quo in the Middle East. Indeed, if the economic recession would prove to be shorter and more manageable than expected, then the Obama administration will be in a position to embrace a more ambitious agenda in the Middle East - accelerating the withdrawal from Iraq through a regional framework that could include Iran. The best-case scenario would be some sort of a grand diplomatic bargain with Iran, that could lead to the suspension of its nuclear military programme and the restraining of its regional allies, such as Hizbollah and Hamas.

That kind of diplomatic momentum taking place in a stable regional environment would be more conducive to the re-starting of Israel-Palestinian negotiations and would demonstrate perhaps that the road to Jerusalem goes through Washington.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.