Daily Archives: June 20, 2012

Pity Ben Bernanke and his colleagues on the Federal Reserve’s main policymaking committee. Once again they felt compelled to do something to be seen as countering a renewed slowing of the domestic economy that is compounded by a deepening European crisis and less buoyant emerging economies. But in continuing to act on its own, all the Fed will do is buy some time that will again be wasted by the country’s politicians. Meanwhile, collateral damage will mount, making the next policy steps even more excruciating.

It is not so long that the Fed was discussing how to exit the unconventional policy phase initiated in the midst of the 2008 global financial crisis. Instead, and having already ballooned the balance sheet to 20 per cent of US gross domestic product, it will now exchange even more of its short-term Treasury holdings (up to 3 year maturities) for longer-dated (6-30 year) bonds. This extension of “operation twist” has, as an intermediate objective, repressing market interest rates to push investors to assume more risk, trigger the wealth effect and reignite animal spirits. The ultimate objective is, of course, to promote non-inflationary growth.

While the Fed has been able to normalise market functioning and boost valuations, it has repeatedly failed to deliver on its desired economic outcomes. Unfortunately, there is little to suggest that things will be any different this time around.

Whether you are worried about insufficient demand or the economy’s sluggish supply response, it is hard to argue that what ails the US is in the domain of Fed tools. The most it can do is buy time while trying to inform and —  at the margin — influence steps that can only be taken elsewhere.

The Fed can again try to slow the inevitable deleveraging of over-indebted parts of the private sector. But, given the liquidity trap, it won’t meaningfully counter lower government spending, consumers’ debt overhang and less dynamic export markets. It cannot get congress to agree on fiscal reform, nor will it remove the housing inventory, revamp housing finance, boost infrastructure, and enhance labour retraining and retooling.

What this continued Fed activism will do is to continue altering the functioning of markets, contaminate price discovery and distort capital allocation. Already, the viability of several segments – from money markets to insurance and from pension provision to suppliers of daily market liquidity, all of whom provide financial services to companies and individuals – has been undermined. The Fed has also conditioned many market participants to believe in a policy put for both equities and bonds. And other government agencies are relieved to have the policy spotlight remain away from their damaging inactivity.

Yet, judging from Wednesday’s decision, the Fed remains undeterred. This is not due to a lack of recognition of the increasingly unattractive balance between what Chairman Bernanke called in August 2010 the “benefits, costs and risks” of unconventional policies. Instead, I suspect that Fed officials feel a moral obligation to act when others won’t; they worry that their flexibility will erode as they get closer to the November elections; and the last thing they want is to inadvertently contribute to a sluggish US economy that would accentuate the synchronized slowing now taking holding of the global economy.

The Fed also remembers last summer when political brinkmanship over the debt ceiling took the country to the edge of a technical default and contributed to the loss of a triple-A sovereign rating. Now, due to the serial postponement of key congressional decisions, the US faces the menace of an end-year fiscal cliff – a disorderly contraction of some 4 per cent of GDP through arbitrary spending cuts and across-the-board tax increases – at a time when the economy as a whole is on course to deliver at best just 2 per cent in annual growth.

Wednesday’s decision signals that America is falling further behind its first best policy responses. And while the Fed should be commended for trying to deliver a second best, net benefits will prove even more difficult to secure. In the process, look for greater distortions that will take years to resolve.

Pakistan’s President Asif Ali Zardari is unlikely to challenge the Supreme Court’s decision to dismiss his Prime Minister Yusuf Raza Gilani and deprive him of being a member of parliament for five years. However Mr Zardari’s attempt to avoid a confrontation with the courts that could result in country-wide violence and the return of the army stepping, could also open the door to his own judicial dismissal.

For four years there has been a steady and increasing rise in conflict between Chief Justice Iftikhar Chaudry and the ruling Pakistan’s Peoples party. The courts have failed to try and dismiss Mr Gilani and Mr Zardari. Mr Gilani was convicted on April 26 for protecting Mr Zardari in a corruption case, but also for refusing to accept the court’s interference and jurisdiction in the constitution. Pakistan’s parliamentary democracy and constitution gives the power of sacking a prime minister to parliament — not to the courts.

Given the economic, social, foreign policy and political crises faced by the government, Mr Zardari and the PPP have decided not to block this second attempt by the Supreme Court to sack Mr Gilani. There have been three days of widespread rioting in the Punjab province due to massive cuts in electricity just as summer temperatures are soaring, there is a severe economic crisis, a state of civil war in Balochistan province and the continued terrorist actions by the Pakistani Taliban. Meanwhile Pakistan’s relations with the US and its Nato allies are not improving.

What happens next? In these dire circumstances a confrontation between the courts and the government over whether Mr Gilani should resign or not, in which ultimately the courts call upon the army to intervene on their behalf could easily lead to the country’s fifth martial law. Mr Zardari may be trying to avoid that by calling upon his party to show calm and quickly nominating a new prime minister from the PPP, who will easily get sworn in by Parliament because the PPP and its political allies hold the majority.

However that is unlikely to satisfy the opposition parties — led by politicians such as Imran Khan and Nawaz Sharif — who are demanding early general elections (these are due in spring 2013 but could be bought forward to the end of 2012). The opposition has broad support for its demand because of the multiple failures of the government. It may be Mr Zardari’s best bet to agree to early elections and take his party to the hustings as a martyr in the cause of the democracy. It would keep the army in its barracks and sustain the democratic process despite its heavily tainted appearance right now.

If the PPP wishes to fulfil its full term until 2013 there are likely to be more bruising conflicts between the courts and Mr Zardari. One issue that is hanging over Pakistani heads is the so called Memogate affair in which a judicial commission formed by the Supreme Court found former Ambassador to the US Hussain Haqqani guilty of treason. Mr Haqqani, who now lives in the US, vehemently denies the allegations. That judgement is now in the hands of the Supreme Court, which is likely to send it for a full trial in the weeks ahead. If that happens the case will also try and implicate Mr Zardari and other government figures for treason. Avoiding such an outcome would be best for everyone and early elections is the only possible way that Pakistan could get back on the rails.

Related links:
Pakistan coverage – FT
Waking up to war in Balochistan – Ahmed Rashid (BBC News)

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