Friday, June 27, 2008


Donald Kohn, Vice-Chairman of the Board of Governors of the Federal Reserve System gave a speech yesterday at the International Research Forum on Monetary Policy in Frankfurt, Germany. (See In that speech, Mr. Kohn spoke about “Global Economic Integration and Decoupling.” Decoupling, according to Kohn, “refers to apparent divergences in economic performance among different regions of the world economy.”

Kohn references three different aspects of this. First, “the business cycles of the United States and other industrial economies are becoming less synchronized…” Second, “economic growth in the emerging market economies is holding up, even as growth slows substantially in the United States and, to a lesser extent, elsewhere in the industrial world.” Third, “even as the financial markets of many industrial countries have been roiled by turmoil that emerged last August, conditions in the traditionally volatile financial markets of emerging market economies have proved surprisingly resilient.”

To me, this speech misses the point and represents one of the major reasons why the Federal Reserve and the leaders of the Federal Reserve are facing a real crisis of credibility. (See my post on “Credibility” of June 23, 2007, The Federal Reserve is ignoring any role it has played in the decline in the value of the dollar over the past six years and the dislocations in world markets that this has caused. By continuing to ignore the role it has played in the decline in the value of the dollar it is undermining any remaining trust that might exist in its leadership.

And, the Fed is ignoring the role it is playing in the current financial turmoil. Concern over the behavior of the Federal Reserve is being expressed around the world. See for example the editorial comment in the Wall Street Journal, “The Fed at Ease”, Also see the editorial comment in the Financial Times, “Fed cannot ignore global inflation”, Yet, policymakers in the United States seem to turn their eyes elsewhere.

The Federal Reserve Open Market Committee met on Tuesday. It presented the results of that meeting Tuesday afternoon and the statement made was, if anything bland and tepid. The statement basically said…we really aren’t in the mood to do anything at this time.

That was sure a confidence builder!

This Federal Reserve leadership has introduced more innovation into the world monetary system than any before it. It has broadened the scope of financial oversight tremendously, even assisting in the Bear Stearns takeover, and is seeking more and more responsibilities. It is now looking at opening up the banking sector to private equity investment.

We are walking in new territory…never before explored. For example, we don’t know what all the new innovations mean for the future. We have been told that many of the actions taken will be removed in the future when the need for them recedes. Yet we see that there exists $150 billion in Term Auction Credit outstanding, $64 billion in “Other Credit Extensions” which includes swaps to central banks in Europe, $8.5 billion credit extension on the “Primary dealer credit facility” and $111 billion in securities lent to dealers in through the “term facility” window. What do all these billions mean for the financial institutions and financial markets? How will they be removed?

We don’t know what these innovations mean. We have nothing to compare them with!
And, then we seem to have leaders that are doing little or nothing to help their credibility in world financial circles! Where should the confidence come from?

Let me just say that if this attention on the credibility of Fed leadership is getting into the newspapers then we need to be concerned. In my experience, newspapers tend to be a lagging indicator of how participants in the market feel. If the newspapers are expressing concern over the credibility of the leadership of the Federal Reserve, then the rest of the world must be really concerned!

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