WHO WANTS TO BE A CENTRAL BANKER ? / BARRON´S MAGAZINE ( VERY HIGHLY RECOMMENDED READING )

Up and Down Wall Street

TUESDAY, AUGUST 31, 2010

Who Wants To Be a Central Banker?

By RANDALL W. FORSYTH

They can't fix economy's problem but get the blame. Japan's Woes: "We should be so lucky."

CENTRAL BANKERS AREN'T having the best of times lately. They're damned if they do and damned if they don't.

Federal Reserve Chairman Ben Bernanke was credited with a sharp rebound in stock prices and an equally sharp drop in Treasury prices Friday after his Jackson Hole speech. The U.S. economy has fallen short of the central bank's expectations but he assured his audience the Fed still has tools in its kit should the economy falter more. By Monday, however, the effect of the Fed chief's words had worn off and stocks slumped and Treasuries rebounded.

Bernanke's counterpart at the Bank of Japan, Masaaki Shirakawa, made a hasty exit from the Jackson Hole confab after both Prime Minister Naoto Kan and Finance Minister Yoshihiko Noda last week called for changes in monetary policy to rein in the yen, which traded at a 15-year high with the dollar fetching less than 84 yen at one point.

The Nikkei 225, which had sunk into bear territory in part because of the yen's crimp on exports, initially rallied 3% early Monday in expectation that Japan's central bank would dip into its arsenal to halt the advance of its currency. Instead of the big gun of intervention in the foreign exchange market, after an emergency meeting the BOJ opted for the low-caliber approach: an increase in a lending facility to banks to ¥30 trillion from ¥20 trillion.

Subsequently, the Nikkei plunged 3.6% Tuesday in a sharp retreat led by exporters over disappointment over the failure to bring down the yen.

The Nikkei gave back a third of its gains and the yen, after an initial sell-off, was back to close to its highs. Shirakawa got virtually nothing for his trouble of shuttling back and forth across the Pacific except jet lag on both ends without getting to enjoy the Grand Tetons.

But the BOJ head apparently is faring better than his counterpart at the People's Bank of China, Zhou Xiaochuan, who is rumored to have fled the country, according to Stratfor, the private intelligence service.

Early Tuesday, Stratfor confirmed that the rumors swirling around the blogosphere about China's central bank head's disappearance and possible defection to the U.S. were false.

As colleague Tiernan Ray notes on the Stocks to Watch blog, the PBOC was rumored to have lost $430 billion on China's massive holdings of Treasury securities. Given that Treasury yields have fallen to historic lows for short-to-intermediate notes, and the renminbi has barely budged against the dollar, China should be sitting on capital gains on its Treasury portfolio. If it isn't, one inference to be drawn is that the PBOC was hedging its holdings and lost on those hedges.

Zhou published calls last year for supplanting the dollar as the key international reserve currency with an international currency. He recognized that the U.S. could effectively issue IOUs nearly without limit because the rest of world used those liabilities as their assets and the main medium for exchange for trade and capital markets. It would not be far-fetched to infer he was chary about China's holdings of U.S. assets.

Japan's plight may not be as dire as its nominal exchange rate implies. According to Bloomberg, Eisuke Sakakibara, who as Minister of Finance in 1997-99 came to be known as "Mr. Yen" for his efforts to influence the currency's value, asserts today's exchange rate of 85 yen to the dollar isn't the same as the 80-ish to the dollar back in 1995. The domestic deflation in the intervening years makes Japan far more competitive. According to one calculation, the yen would have to equal just 55 to the dollar for its real exchange rate to be the same as 15 years ago. So, the yen has been less of a hardship than its nominal exchange rate versus the dollar implies.

Even so, the specter haunting U.S. officials is that America would have to go through the deflationary lost decades of Japan. To which, David Goldman retorts, "You should be so lucky."

"During Japan's 'lost decade' of the 1990s, everyone was working, everyone kept their homes, everyone maintained their lifestyle (minus some shopping trips to Paris), and life carried on more or less the same. America enters the second decade of the millennium with un- and underemployment around 20%," the former head of credit research at Bank of America and current senior editor of First Things magazines writes on his Inner Workings blog at Asia Times.

Japan was able to export to earn the income to fund the retirement wave it faced from its aging population, Goldman continues, despite a plunge in consumption and a two-thirds collapse in stock prices from their peak. Americans have forgotten how to export; they have little choice but to cut spending and save and invest in 2.5% Treasuries, or junk bonds, or leave their money in the bank at a fraction of a percent.

Their plan had been to buy a house, mortgage it to the hilt, borrow more to finance spending on cars and vacations, and then sell it at a huge price. That would pay for a nice retirement. I know folks who bought a $40,000 house in 1970 and sold it for $800,000 in 2005 with a relative pittance left on the mortgage. And they had a defined-benefit plan that paid a guaranteed pension. That world is gone for most Americans.

And so, U.S. policy-makers wonder what to do. "Bernanke seems authentically perplexed," Goldman writes. "He followed the instructions to the letter, mixing the eye of newt with the tongue of bat, and adding $2 trillion in securities to the witches' brew–but nothing seems to have happened."

President Obama has set a goal of doubling American exports, the path that Japan took to cushion its decline. It did so by cutting prices domestically, which is the definition of deflation. That also is the tack taken by Germany; curbing prices and wages has helped power an export boom. It also helps if you produce what's in demand, such as capital goods for China.

Ultimately, central-bank governors cannot cure such problems by manipulating interest rates, exchange rates and money supplies. Creation of real wealth, as opposed to paper wealth, is lots harder.

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