WASHINGTON -- Prior to the recent global financial crisis, the Federal Reserve Board under Chairman Ben S. Bernanke was ready to take a subtle step toward easier money in order to stave off U.S. recession fears. Ready for approval in the immediate future was a new Federal Open Market Committee (FOMC) statement taking the central bank off neutrality and putting it on a bias for an interest rate cut. But international credit scares changed all that.
The Fed and other central banks moved quickly and in unison last Friday to pump more cash into financial systems, successfully stabilizing markets made jittery by collapsing hedge funds around the world. It was central banking at its best, avoiding "panics" that would have resulted from such a situation a century ago. But Bernanke's broader plans for easier money have to be placed on hold because he cannot be seen bailing out greedy hedge fund operators.
The cautious Bernanke shoulders a burden not faced by his often error-prone predecessors. Because of the global economy, he is central banker for the world. The recent credit crisis originated in the failure of American sub-prime home mortgages backing securities held in Europe. The complicated equation that Bernanke ponders also involves the rest of the industrial world growing at a faster rate than the United States, leading some to speculate about tightening by the foreign central banks.
The Fed's operations today are vastly more transparent than they were in the 1960s when I first attempted to decipher the secrets of the marble temple on Constitution Ave. While the FOMC's decisions now are disclosed promptly, the central bankers do not disclose and try not to leak future plans. However, according to Capitol Hill sources, they had secretly decided to issue a statement soon changing the Fed's bias toward easing -- which no longer would be in neutral.
While such a change in itself can boost the economy, it normally is followed immediately by an actual drop in interest rates. In this case, however, sources indicated that the second step would not come for several months, to coincide, if possible, with good anti-inflation numbers. That would soften the perceived inflationary risk of boosting the economy.
But any kind of easing now -- either just abandoning neutrality or a full-scale interest rate cut -- could make it appear Bernanke was less interested in the broader economy than in protecting millionaire hedge fund operators and traders. The credit crisis began with the collapse of two mortgage-connected Bear Stearns hedge funds, at a cost to investors of more than $1 billion. Central bankers do not want to be regarded as bailing out Wall Street risk-takers.
Bernanke's primary responsibility for the past week has been to coordinate with his fellow central bankers around the world and avert a global catastrophe. The Federal Reserve, European Central Bank, Bank of Japan and Reserve Bank of Australia combined to put cash into the system. Financial markets calmed, and the dollar rallied after a representative of the People's Bank of China on Monday called U.S. dollars and government bonds "an important part of China's foreign reserve investments."
Even the chairman's critics commend his handling of the first major crisis in 18 months on the job. They say the departed "Maestro," Alan Greenspan, would have acted identically -- with a single exception, in the opinion of one Fed watcher. He feels Greenspan would have leaked plans for an interest rate cut in the future to show his overriding concern about the U.S. economy.
Domestic economic indicators released on Tuesday pointed in various directions. On the bearish side, Wal-Mart and Home Depot separately reported profits that were less than expected. On the bullish side, the U.S. trade deficit dropped to an all-time low as exports reached new highs. On Wednesday, the consumer price index rose 0.2 percent (a 2.1 percent increase for the year) -- not clearly showing whether inflation is worrisome enough to inhibit the Fed from easing.
As Bernanke considers his course, the "R" word (recession) is in the Washington air. That's the reason for the Fed's secret decision to move away from neutrality toward easing, which is now on hold thanks to the global crisis.