Posted by: Dirk | March 10, 2009

Is Geithner fit for the job?

Paul Krugman in last week´s NYT column described the economic policy priorities of the Geithner/Bernanke team:

Thus, in a recent interview Tim Geithner, the Treasury secretary, tried to make a distinction between the “basic inherent economic value” of troubled assets and the “artificially depressed value” that those assets command right now. In recent transactions, even AAA-rated mortgage-backed securities have sold for less than 40 cents on the dollar, but Mr. Geithner seems to think they’re worth much, much more.

And the government’s job, he declared, is to “provide the financing to help get those markets working,” pushing the price of toxic waste up to where it ought to be.

What’s more, officials seem to believe that getting toxic waste properly priced would cure the ills of all our major financial institutions. Earlier this week, Ben Bernanke, the Federal Reserve chairman, was asked about the problem of “zombies” — financial institutions that are effectively bankrupt but are being kept alive by government aid. “I don’t know of any large zombie institutions in the U.S. financial system,” he declared, and went on to specifically deny that A.I.G. — A.I.G.! — is a zombie.

This post coincides with some harsh criticism of the role Tim Geithner played at the IMF during the Asian Financial Crisis by Paul Keating, former Australian prime minister, published in the Sydney Morning Harald on Saturday:

In a speech to a closed gathering at the Lowy Institute in Sydney on Thursday, Paul Keating gave a starkly different account of Geithner’s record in handling the Asian crisis: “Tim Geithner was the Treasury line officer who wrote the IMF [International Monetary Fund] program for Indonesia in 1997-98, which was to apply current account solutions to a capital account crisis.”

In other words, Geithner fundamentally misdiagnosed the problem. And his misdiagnosis led to a dreadfully wrong prescription.

The consequences were dire:

Worse, Keating argued, Geithner’s misjudgment had done terminal damage to the credibility of the IMF, with seismic geoeconomic consequences: “The IMF is the gun that can’t shoot straight. They’ve been making a mess of things for the last 20-odd years, and the greatest mess they made was in east Asia in 1997-98, so much so that no east Asian state will put its head in the IMF noose.”

China, in particular, drew hard conclusions from the IMF’s mishandling of the Asian crisis. It decided that it would never allow itself to be dependent on the IMF, or the US, or the West generally, for its international solvency. Instead, it would build the biggest war chest the world had ever seen.

This has been noted by Nouriel Roubini, among others:

The paper argues that the current East Asia financial and currency policies represent a return to fixed exchange rates as most – but not all – of the policy makers in the region are aggressively preventing a necessary currency appreciation via massive and growing amounts of forex reserve accumulation. Such reserve accumulation has been at the rate of $450 billion in 2006 alone and now at an even faster rate in 2007. By now the stock of forex reserve in Asia is over $2.5 trillion and rising rapidly.

These policies are however creating – via partially sterilized intervention – a massive growth of monetary base and of credit in Asia that is feeding a variety of asset and financial bubbles as well as leading to goods inflation in some countries; these bubbles are dangerous and likely to lead to a financial bust over time.

These currency policies – effectively what has been referred to as the Bretton Woods 2 regime of fixed rates in Asia – have also made East Asia more dependent now than ever before on the US business cycle and on growth developments outside of Asia. Thus, China and Asia are now seriously vulnerable to a US hard landing that now looks more likely.

These Asian currency and financial policies have also contributed to global current account imbalances, to excessive global liquidity, to the bubbly conditions in a variety of global – not just Asian – asset markets and to a serious underpricing of risk in global financial markets.

Now, having this information available, I seriously doubt whether Tim Geithner is fit for the job. The IMF during the Asian financial crisis prescribed very bitter medicine for Indonesia, which led to much politicial turmoil, so that in the end the reforms were abandoned. During this episode, the decision to close some banks lead to a banking panic, according to a text by Gerald O¨Driscoll at the conservative Heritage Foundation (see footnote 10). This might lead one to think that Tim Geithner would try to save the banks at whatever costs, which means following Japan´s example by creating zombie banks. Now everybody knows that Japan has had a dismal growth record since they did exactly that.

Probably this is the last moment to discuss where economic policy is leading us (or the US). Once zombie banks are created and deflation arrives, it might be too late to undo policy mistakes of the past. But president Barack Obama does not read blogs:

“Part of the reason we don’t spend a lot of time looking at blogs,” he said, “is because if you haven’t looked at it very carefully, then you may be under the impression that somehow there’s a clean answer one way or another — well, you just nationalize all the banks, or you just leave them alone and they’ll be fine.”

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