The ambush waiting for Bernanke
MOST FED chairmen are blindsided early on in their tenure.
Alan Greenspan faced a stock market crash two months after he took over in August 1987. Paul Volcker had to cope with a rout in the bond market three months after he became chairman in August 1979. G. William Miller was challenged immediately by a dollar crisis in the spring of 1978. For Arthur Burns, it was the inflation bogie in the early 1970s.
What's more, this indoctrination by fire has tended to take the new Fed chief -- who is arriving without his predecessor's hard-won credibility -- well out of his comfort zone.
Burns, the business cycle expert, was ill-equipped to cope with inflation. Miller, the businessman, didn't understand financial markets. Volcker, the expert on international finance, had to deal with a major recession. And Greenspan, the business consultant, was thrust into crisis management.
Ben Bernanke, I suspect, will meet a similar fate. It's true that, on the surface, he seems to be the perfect candidate to deal with the one problem everyone is worried about today -- inflation. The oil shock of 2005 has taken retail energy prices up 35% over the last year, and there are 1970s-style fears that a spillover to other prices can't be too far behind.
And Bernanke is widely thought to be the perfect central banker to cope with this problem. He is renowned for his skills as an inflation fighter. He has led the charge in the academic debate over "inflation targeting" -- arguing that a central bank needs to be explicit in aligning its policy instrument (the federal funds rate) with a numerical target of price stability (a 1% to 2% increase in the "core" consumer price index).
But I suspect that the current inflation scare will turn out to be a false alarm. As always, energy prices will come down when demand sags -- some of that may already be occurring -- and the new and powerful forces of globalization should continue to hold other prices largely in check.
The U.S. economy actually faces far greater threats than inflation -- threats that an inflation targeter such as Bernanke may be ill-equipped to deal with.
At the top of the list is a record U.S. current account deficit -- the broadest measure of the nation's trade balance (imbalance, in this case) with the rest of the world. Running at an annual rate of close to $800 billion in the first half of 2005, it requires foreign funding to the tune of $3 billion per business day. To accomplish that without a sharp drop in the dollar and/or a related backup in interest rates requires extraordinary confidence on the part of foreign investors in U.S. assets.
