Brad Setser

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Who would sit on today’s “committee to save the world”

by Brad Setser
October 28, 2005

That is one of many interesting issues raised by Times selectman Floyd Norris today.

As Norris notes, Alan Greenspan never had half the power people thought he had.  All he does is set short-term (credit) risk free US rates.   The markets set most other rates. And increasingly, policy decisions elsewhere shape some of those key rates (ten year Treasuries, anyone).

More importantly, the US is not the financial power it once was.  That reality likely implies, should something happen, that the composition of the Committee to Save the World (that was the name Time magazine gave to Greenspan, Rubin and Summers after the 97 Asian crisis and the 98 LTCM/ Russia/ Brazil crisis) would need to change.

"Mr. Greenspan's power and prestige probably peaked in the late 1990's.   That was symbolized by the 1999 Time magazine cover that proclaimed the "Committee to Save the World" with him as chairman, and Treasury Secretary Robert E. Rubin and his deputy, Lawrence H. Summers, as lesser members.   Now the financial power of the United States, and thus of the Fed, is reduced, a trend that Mr. Bernanke has been a leader in analyzing.  Given who owns dollars, if a similar committee were needed now, it would not be an all-American one, and probably would have to include someone from China."

The US has become dependent on an interest rate subsidy from our external (official) creditors.  That gives them a seat at the table.   A sudden withdrawal of the subsidy would be rather disruptive.  If oil prices stay high, the Russians and Saudis probably get a seat at the table as well.   Talk about change.

The composition of the Committee particularly needs to change if in some sense it is the US – not the world – that needs to be saved.  The US obviously has an enormous impact on the rest of the world, so the US cannot be separated out from the rest of the world.  But capital (on a net basis) pretty much flows one way right now: from the rest of the world to the US.  That is big change from 97-98, which was all about managing the consequences of a big drop in private flows to the emerging world; the next crisis is likely to be a bit different.  See Roach, who, after flirting with being a bond bull, is back to his bearish current account obsessed self.

Another point, one also highlighted by Paul Krugman.  

The Federal Reserve Board is not the only economic policy making institution that matters: 

Greenspan made one key decision as part of the committee to save the world: he cut rates in 1998, after Russia and LTCM.   That rate cut had the desired effect – and I do not want to minimize its impact.

But it was hardly the only key decision.

William J. McDonough of the New York Fed (controversially) stepped in to encourage LTCM's creditors to bail it out.   Greenspan gave at least his tacit consent, but the point person was McDonough.


And the Treasury did a thing or two as well. It

  • Supported an IMF loan to Thailand, though not as large a loan as the Thais wanted
  • Supported a big loan to Korea, and when that proved insufficient to stop the run, the Treasury twisted the arms of a few banks to encourage them to stop pulling their short-term credit lines.  That policy worked.
  • Supported IMF lending to Indonesia but only if Suharto made big changes to Suharto, inc –
  • Supported a $5 billion cash infusion to Russia in the summer of 1998, but then pulling the plug after only one installment of a bigger financial package in August, once it became clear that Russia was not getting its fiscal house in order (and market rates were not coming down).  Pulling the plug was a big deal.  The NSC did not want to do it.  But Rubin did not think the conditions for success were there – read his memoirs.  He was right.
  • Supported a series of IMF programs for Brazil: an unsuccessful one that tried to defend Brazils peg, and a successful one that helped Brazil transition off its peg and address its fiscal problems. Rubin's view is that even the first program was a limited success – it meant Brazil devalued only after the markets calmed. 

And Rubin and Summers (with the support of Clinton) ran a classic counter-cyclical fiscal policy in the face of the equity bubble, building up "fiscal ammunition" for the bursting of the bubble.  The surge in tax revenues associated with a surging stock market was saved rather than spent.

My point: the Treasury matters.  It has far more policy levers to pull than the Fed, even if each of those levers individually lacks the global punch of policy interest rates.  And if – as is widely suspected – John Snow steps down, the choice of a new Treasury secretary will matter too. 

Bernanke's job in a crisis will be a lot harder if fiscal policy works against monetary policy – and right now, it looks like the US is heading for a tight(er) monetary policy, loos(er) fiscal policy mix for 2006.   I am not sure that is the best of all possible policy combinations.

If a Bush White House that is under stress caters to its "base" and picks a Treasury secretary to sell a tax "reform" plan that is designed to mobilize the "economic conservative" part of the base of the Republican party with tax cuts disguised as tax reform for the 2006 midterm elections, I would really start to worry.

On the plus side, Tim Adams has brought some energy to the Treasury International Affairs staff, and the Administration's pick (Adams' pick?) for Assistant Secretary for International Affairs – Clay Lowery – is everything the Administration should be looking for in all its appointments (smart, sensible, competent, experienced).  Full disclosure: Clay was part of the Treasury career staff, so we worked together on "debt" issues a few years back. I confess to being biased.

Update: More on the "diminished Fed" from Rich Miller of Business Week.  Note the Summers quote.


  • Posted by vorpal

    I would posit that V. Putin is the most powerful man in the world.

  • Posted by Anonymous

    Much of this seems to miss the point. It is not what Greenspan controls or the institution that gives him power. It is his ability to mobilize appropriate resources to avert a potential calamity. Greenspan could pick up the phone and call anyone in the world for guidance, he has the intelligence to call the right people, and the humulity to delegate. With all due respect, neither current nor past Treasury leadership seems to compare (if for no other reason, the duration of their terms). Besides, the more interesting debate is whether these responses are appropriate in the first place. One could make the case that bail-outs such as LCTM encouraged inappropriate risk taking behavior down the road, and will lead to a crisis that no government can solve with a band-aid. Market solutions to today’s problems generate stronger, more open markets in the future.

  • Posted by bsetser

    Greenspan’s greatest asset was his credibility; if he said it, folks thought it was true. He could move markets with his words, and reassure when reassurance was needed.

    LTCM certainly raises real issues, and potentially encourages risk taking. But the “bailout” was private, the new capital to recap LTCM came from its creditors, so that minimizes the moral hazard. The fed pushed the key market actors to come up with a market solution before things got out of hand,and to coordinate before, not after, formal default. i think that is an appropriate role for government; otheres disagree. To me, the bigger issues come from the expectation that the Fed can save the world with a few rate cuts, which may well have the effect of encouraging more risk taking.

    But I disagree that the Fed alone possessed credibility, a golden rolodex and the intelligence to get the right people on the phone. Rubin could get the right people on the phone, and made a point of listening to a broad range of views. and i stand by my argument that the Treasury (acting alone or acting together with the Treasuries/ finance ministers of the world) often had at its disposal key resources.

  • Posted by Guest
  • Posted by Gcs

    “The markets set most other rates”

    is a sentence like this a hand wave
    why feel you’ve determined anything by stating this
    or are we to make of it what we will
    depending on what manner of beast
    we take debt markets to be ???

    ” And increasingly, policy decisions elsewhere
    shape some of those key rates
    (ten year Treasuries, anyone)”

    “shape?? ”

    true only when the fomc plays laissez faire

    why pretend the fomc lacks means to effectively intervene
    when u mean to say
    it may lack motivation

  • Posted by bsetser

    Read all of Rajan’s speech; at the end, doesn’t he kind of abdicate? (china is moving toward flexibility, we shouldn’t do any more)

  • Posted by MarkV

    It seems like Asia would rather deal with the currency aspects of rebalancing through inflation rather than revaluation. The purchasing power of a dollar in Asia does appear to be falling now even in the absence of significant exchange rate changes.

    India: Desperately Seeking Talent
    As India’s domestic economy expands, the shortfalls are spreading beyond tech. Wages for semi-skilled workers in the textile factories of Coimbatore, for example, are up 10% this year, while supervisors’ salaries have risen by 20%. Pay in the banking industry is up 25% in the past year and has more than doubled in hot areas such as private equity. Airline pilots have seen wages rise 25%. Overall, Indian salaries will rise by 12.8%, compared with inflation of 5.5%, according to human resources consultancy Mercer, which warns that continued increases could hurt India’s economic revival.

  • Posted by bsetser

    India and China look quite different right now: India = current account deficit, inflation higher than us inflation, etc. China = current account surplus (a growing surplus too, even in the face of a serious oil shock) and lower inflation than in the US. no doubt there are some supply bottlenecks there too and labor costs are rising, but the inflation differential alone is eroding the real appreciation v. the US due to the 3% or so reval.

  • Posted by Emmanuel

    I volunteer Bank of China governor Zhou Xiaochuan. A representative from America’s creditor of last resort should have a seat at the table to show the world who’s boss in today’s geopolitical arena!

  • Posted by JS

    I don’t think Rajan was claiming China was moving enough toward flexibility or that the US was doing enough to lower the CA deficit. I read him as saying that China cannot afford the domestic consequences of a large interventionist appreciation, that instead China should move towards de-pegging and let the market determine the exchange rate and that China needs to be much more flexible very soon. He also argues that the US must reduce fiscal expenditures and raise revenues, and that the US is currently not doing enough to accomplish either of these. So I don’t really think he was abdicating, I think he was just being polite and encouraging while reminding everyone that there was a long ways to go. My problem with his position is if he thinks China should move towards market flexibility, what is to prevent the market from effecting his dread distress for Chinese businesses? My problem with fiscal restraint in the US at this time, either through the form of increased taxes or reduced federal spending, is that the consumption engine that drives the US economy cannot afford increased taxes (our asset bubbles and energy prices make this very dangerous at present) nor can a reduction in government spending and employment have anything but recessionary consequences (not to mention fueling the fires of easy money.) I am not arguing that China should remain pegged, or that the US should continue fiscal excess, but that simply changing these things perhaps ushers in a new set of problems where the cure is worse than the disease.

  • Posted by Anonymous

    Ask elaine for a suitable chinese person.

  • Posted by bsetser

    JS — maybe i was a bit harsh, but I saw Rajan’s comments as consistent with Rato’s policy of do nothing, while saying just enough so that the IMF doesn’t get blamed for being totally silent if everything unravels in an unpleasant way.

    I don’t think shifting the basis of chinese or uS growth will be easy — but i don’t think continuing on the current course makes the eventual adjustment any easier either. it makes it worse actually. while China has talked of flexibility, in practice, this year its economy became more dependent on net exports for growth, not less. And while Rajan talks of the need for better quality investment in china (I agree), he left out that china has become more dependent on investment (meaning inv/ GDP keeps getting bigger, and investment keeps increasing faster than GDP).

    yes, flexibility can be a polite way for saying “Revaluation”, but right now, china’s baby steps toward flexibility are overwhelmed by everything else.

    where i differ from rajan and probably you is that i think a step revaluation is needed to send a signal to the Chinese economy not to keep investing in exports, even if it is somewhat painful, and is also needed to spur china to take the (admittedly challenging) steps to spur domestic consumption rather than continuing to rely on exports and investment for growth. so far, the policy steps taken in china have been insufficient to the task.

  • Posted by JS

    Brad – I take it then that you are agreeing with Rajan on the difficulties Chinese businesses would face with a steep appreciation, but disagree on the ultimate outcome for China. My concern with the outcome of steep and rapid revaluation is Chinese stability in the face of already significant social unrest and rising inequality. Andy Xie recently described demographic, infrastructure and wealth distribution problems in China that I think offer useful policy considerations (even if one does not agree with his account of global imbalance mechanisms) ( I am not saying I condone maintaining competitive currency manipulation (undervalued pegs), but I do think global adjustment should at least partially come from a broader spread of western liberal social infrastructure and the concomitant raised standards of living and different patterns of savings, investment and consumption. I would rather see the world adapt to the pressures of globalization through general notions of progress and overall prosperity than a competitive race to the lowest base of living standards. I’m sure you share my point of view on that, perhaps just not from the perspective as a mechanism for adjustment. Admittedly such an adjustment could be much slower than required to rectify current global imbalances before an unruly adjustment is triggered by the market. I am not in the Dooley et al. protracted adjustment camp, but I do think he is right that under current conditions participants in the system (perhaps through myopia or wishful thinking) do not have a sufficient incentive to adjust now or in the near term voluntarily. My fear, in addition to abrupt market dislocations, is that the current methods of adjustment and non-adjustment share more with the 1930s reminiscence articulated by Rajan, Geithner, Roach and others, than anyone, including them, cares to admit. That is to say that global deflationary pressures, emergent and entrenched neo-mercantilism, aggressive currency manipulation, effete international institutions, an increasingly vulnerable world reserve and a declining world leader share more with the global problems that emerged in the 1920s and 1930s than anyone is really owning up to. It’s not that these things are coming-we’ve started down the path already. Now it’s a matter of do we do an early 2000s version of the 1930s horror movie called “The Great Depression”, or do we try something different. While it’s true that we haven’t yet had a large scale resurgence of the crude policy instrument known as protectionism, some current global practices and remedies mimic the practice and outcome of protectionism in all but name.

  • Posted by bsetser

    keeping the peg helps avoid deflation in china but puts downward pressure on wages and manufactured goods prices in the rest of the world; a revaluation increases the risk of deflation in china (that’s why it needs to be accompanied by offsetting policy changes) but helps the world.

    my concern is that the current policy mix in china — undervalued RMB, loose money (check out s-term rates in china) and rapid (now that the screws have been loosened a bit) lending growth to increase, not reduce, inquality in china. an undervalued RMB encourages rapid development along the coasts (b/c of better links to the world), and the loosish monetary policy plus administrative controls + a bunch of other things means that it makes sense to borrow if you can get a hold of credit, so it favors the already connected. China argues that social stability requires not shaking things up, but keeping the status quo implies keeping the factors that have helped give rise to this inequality in place.

    but i do not want to diminish the difficulties of change, whether here in the US or in china. I do worry though that to date, there has not been bunch of evidence of a real willingness to change on either side of the Pacific.

  • Posted by psh

    And someone from the PLA for staff support to Mr. Zhou. The People’s Liberation Army funds procurement with enterprises in geographically dispersed second-tier markets. They can make money out there in the sticks by relying on their competitive advantage in blowing stuff up to cherry-pick markets and corral competitors into unwanted niches. Who better to plant some seeds of micro structural reform by providing needed services? When ICT was hot they did that; if macro policies favored our current panacea, financial services, would they jump in? Say with agricultural inventory/receivables financing? (It’s not as though it takes much expertise: look at the meagre human capital of our mortgage brokers and Capital One junkmailers.) It’s just a little something they could do before the crisis is upon us.