by Neil Irwin
Trichet had bought the political leaders time to develop a new model for European integration—and the political leaders were squandering it.
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The Alte Oper, Frankfurt’s historic opera house, was built in 1880, leveled by Allied bombs during World War II, and rebuilt in the decades that followed, thanks largely to the tireless exertions of a group of civic-minded local residents. DEM WAHREN SCHOENEN GUTEN, the inscription on the reconstructed neo-Renaissance façade reads: “To the true, the beautiful, the good.”
On October 19, 2011, this monument to grand ideals once again became the locus of a European preservation effort. The event that night was meant to be a celebration—an evening to honor Jean-Claude Trichet, now less than two weeks from his retirement from the ECB, for his four decades of dedication to the European idea. But as it turned out, a few of the officials who’d gathered to toast Trichet would spend much of the night not in the Oper’s mahogany-paneled Great Hall enjoying the scheduled entertainment, but in an out-of-the-way meeting room trying to hash out the European Financial Stability Facility.
Some eighteen hundred people filed into the opera house that Wednesday evening. One after another, the titans of European integration took the stage, the flags of the European Union behind them: former French president Valéry Giscard d’Estaing, former German chancellor Helmut Schmidt, the presidents of the EU’s other major institutions—Herman Van Rompuy of the European Council, José Manuel Barroso of the European Commission, Jean-Claude Juncker of the Eurogroup. Angela Merkel spoke. So did Mario Draghi, soon to be Trichet’s successor.
But it was Schmidt, who’d been among the key architects of the euro, whose speech was the most memorable. “The Executive Board of the ECB, led by Trichet, is the only body that has proved itself to be capable of action and effective during the financial and sovereign-debt crisis,” raged the ninety-two-year-old former chancellor from his wheelchair. “All the talk of a so-called ‘euro crisis’ is thus just the idle chatter of politicians and journalists. What we have, in fact, is a crisis of the ability of the European Union’s political bodies to act. This glaring weakness of action is a much greater threat to the future of Europe than the excessive debt levels of individual euro area countries.”
Trichet then took the lectern, looking as if he’d aged more in one year than in the previous decade. His speech, delivered with his usual self-confidence but more than his usual emotion, evoked the distant past. “The single currency is an ancient idea, which has deep roots in history,” he said, invoking the Roman Empire and a fifteenth-century Bohemian king who called for a common European currency. “The major weakness of the Economic and Monetary Union lies in its insufficient governance of the economic union, while the monetary union has delivered according to expectations. The need to strengthen economic governance is the first lesson from the crisis. . . . I have continuously called for a ‘quantum leap’ in governance.”
After the speeches were done and Trichet had basked for a bit in the thunderous applause, he and several of those who’d toasted him retreated to a side room to try to figure out what form that “quantum leap” might take.
Christine Lagarde of the IMF was present. So was Nicolas Sarkozy, who had left the side of his wife, who was in the hospital giving birth, to fly in at the last minute. He had tried to sneak in through a side entrance, but it is exceptionally difficult for the president of France to show up at an event well attended by journalists and not be noticed. The most powerful actors on the European stage were in one room, and the clock was ticking: In four days, they were scheduled to attend what was supposed to be their last debt-crisis summit, the one that would resolve their differences for good.
They called themselves the Groupe de Francfort, and they would even have special badges identifying them as such at an international economic gathering a few weeks later. Sarkozy argued for giving the European Financial Stability Facility a bank charter—and was smacked down by Merkel and Trichet. A complicated plan to use IMF funds was similarly rejected.
The arguing between Sarkozy and Trichet became so intense that they often lapsed into their native French rather than the English that was the primary language of such meetings. The two men had often clashed over what Sarkozy viewed as Trichet’s excessively doctrinaire view of monetary policy, and the French president’s absence from the speech-giving earlier was no coincidence. There were some minor things they could agree on. But the major question, of how the Frankfurt Group might finally take the quantum leap of integration Trichet had demanded, hung in the night air with no answer.
Draghi soon slipped out to attend the concert already in progress in the Great Hall, a symphonic program cosponsored by the ECB and the Banca d’Italia that was the inaugural event in that year’s monthlong “Cultural Days of the European Central Bank” celebration. Bologna’s Orchestra Mozart, led by legendary conductor Claudio Abbado, would be performing compositions by its namesake, by Rossini, and by Mendelssohn. The last was represented by his Fourth Symphony, which had been inspired by a trip to Italy the German composer took in the early 1830s. In a letter sent home in 1831, he predicted that the so-called Italian symphony would be “the jolliest piece I have ever done, especially the last movement,” which was modeled on exuberant Neapolitan and Roman folk dances.
As Trichet and Merkel and Sarkozy hammered at each other in their back room, no resolution to be found, the notes of Mendelssohn’s finale echoed through the building, the music as jolly as the outlook for Europe was looking dismal.
EIGHTEEN
Escape Velocity
Rick Perry wasn’t merely the governor of Texas; rather, he exuded Texas. The son of a rancher and graduate of Texas A&M University who majored in animal husbandry, he jogged with a loaded pistol, which he claimed to have used to shoot a coyote in 2010. When Perry entered the race for the U.S. presidency in August 2011, he was a popular figure in the nation’s second most populous state, had a huge base of donors, and was the kind of rock-ribbed conservative that Republican Party activists had hungered for. He would eventually fade, with commentators gleefully declaring him more “Texas toast” than Texas. But he initially seemed to many astute political analysts like the man to beat for the Republican nomination.
On August 15, two days after Perry announced his candidacy, a man in a blue polo shirt at a meet-and-greet with voters in Cedar Rapids, Iowa, asked him what he thought of the United States’ central bank. “Oh, uh, the Federal Reserve. I’ll take a pass on the Federal Reserve right at the moment, to be real honest with you,” Perry said, barely pausing as he continued, not taking a pass at all. “I know there’s a lot of talk and what have you about ’em. If this guy prints more money between now and the election, I don’t know what y’all would do to him in Iowa, but we, we would treat him pretty ugly down in Texas.
“I mean, printing more money to play politics at this particular time in American history, is almost treacherous, er, treasonous, in my opinion.”
The crowd applauded. Ben Bernanke had steered the U.S. and world economies away from the financial abyss in 2008, preserved the Fed’s political independence in 2009, and undertaken QE2 in 2010, quite possibly averting a deflationary spiral and a new recession. Now a major presidential candidate was insinuating that, for doing what central bankers do, he would be due for a whuppin’ should he ever find himself in Texas.
At the time of Perry’s comment, the U.S. economy was undergoing its second consecutive summer swoon. The first four months of 2011 had been a time of optimism; the nation added an average of 207,000 jobs a month. But from May to August, that average fell to less than eighty thousand. The unemployment rate was 9.1 percent. There were a variety of explanations for the bad economic numbers, including the onset of more financial strains from Europe, as well as some technical kinks in the data that likely exaggerated strength early in the year and weakness over the summer. But the simple truth is that growth seemed to be
again falling below a pace that would bring unemployment down over time—and that for all of Bernanke’s concerns about what he had’ called “escape velocity,” the Fed had in recent months done nothing new to help the U.S. economy reach it. Bond purchases under the QE2 program ended on June 30, but the Federal Open Market Committee had shown no inclination to reopen it.
The bank had already bought massive quantities of bonds and pushed short-term interest rates to almost zero. What more could it do? It was one thing to have been bold and proactive in late 2008. Three years later, during what was less a sudden panic than a lingering slump, could the Fed adopt the same kind of inventiveness?
Amid internal uncertainty about what would actually help the U.S. economy and external hostility toward the very idea of central banking, Ben Bernanke, it seemed, had a Texas-sized problem.
It was time for the Fed to look again at all available options. But there were two big differences from a year earlier, when the push toward QE2 had begun. The first was that, mainly due to a run-up in fuel costs earlier in the year, inflation was higher—3.8 percent in the twelve months that ended in August, compared with 1.2 percent in the twelve months previous to that.
The second was that Bernanke and his colleagues had experienced the aftermath of QE2, during which seemingly everyone—from conservatives in Congress to high Chinese and German officials—had attacked them for the $600 billion in bond purchases. Central bankers, of course, aspire to do what’s best for their nation’s economy regardless of political attacks or other outside pressure. But in practice, their parameters of what seems wise or acceptable are almost always influenced by the world in which they’re operating. And the continued hostility to easy money in the United States in 2011 meant that the world Bernanke inhabited was one opposed to more Fed easing.
There were some voices arguing for much more aggressive action from the central bank, perhaps most prominently Nobel laureate cum New York Times columnist Paul Krugman. But within the day-to-day political discussion, there was essentially no debate: Republicans were almost uniformly hostile to loose money policies, while Democrats didn’t seem to express any opinion on them whatsoever.
At a July hearing of the Senate Banking Committee, for example, Republican senator Bob Corker—generally a Bernanke supporter—said to the chairman, “I find the activism at the Fed right now a major turnoff, and I am very concerned. And as one person who I think we’ve had a good relationship, I want to tell that you I’m quickly moving to a camp that wants to clip the wings of the Fed, because I do believe that the activism there is distortive of the market, and I believe that . . . something’s causing you to do a lot of things that I think are going to create some long-term damage.” At the same hearing, the committee’s Democratic chairman, Tim Johnson, merely asked in a neutral tone whether Bernanke was considering QE3, offering no real pressure one way or the other.
Bernanke encouraged his staff to brainstorm new ways to ease policy. The blowback to QE2, in his judgment, had itself made the policy less effective. It lowered market expectations of future rounds of easing, and it may even have made businesses and consumers more wary of spending and investing: When commentators loudly complain that the central bank is being feckless and irresponsible, economic actors can hardly feel confident about the future. Fed staffers thus devoted particular effort to methods that weren’t as flashy, that didn’t involve announcing hundreds of billions of dollars in bond purchases.
Fed officials have always sorted their options for easing monetary policy into two groups. One set of tools could be used to adjust the size and composition of the assets on the Fed’s books. QE2 was a prime example. The other is more indirect: using communication of the central bank’s plans and expectations for tomorrow to try to adjust the price of money in the economy today. For example, since late 2008, the Fed had indicated that it expected to keep rates “exceptionally low” for an “extended period.” This was the approach the FOMC elected when it gathered for its regularly scheduled meeting on August 9.
To nudge policy a bit more in the direction of easier money, Fed staff, in their confidential “Teal Book” of analysis and policy options, offered the possibility of expanding on that “extended period” of very low rates. Rather than promising something so vague, the FOMC could assign a specific time period to how long it expected to keep rates low. Bernanke and company decided to adjust their statement to tell the world that they expected economic conditions were “likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” It was hardly revolutionary—analysts already expected rates to stay near zero for nearly that long anyway, so a future of cheap money was already priced into borrowing costs. But it was enough to signal that things had worsened to the point that the Fed was looking for ways to ease policy. It was also enough to anger the hawks on the committee.
Richard Fisher of the Dallas Fed, Narayana Kocherlakota of the Minneapolis Fed, and Charles Plosser of the Philadelphia Fed all voted against the move. It was the first FOMC meeting with three dissenters since 1992, and Bernanke was on notice that any further easing moves would come with significant internal dissent. The action had another potential downside: It seemed to send a pessimistic signal to anyone thinking about making a longer-term investment: We here at the Fed think that things will be SO BAD that we expect to keep interest rates at zero for two more years. At the same time, the chairman had become a punching bag in the Republican primary race. It was almost as if other candidates wanted to catch up with Perry in their Bernanke bashing.
“I would fire him tomorrow,” said Newt Gingrich in a September 7 debate. “I think he’s been the most inflationary, dangerous, and power-centered chairman of the Fed in the history of the Fed. . . . And I think his policies have deepened the depression.” During the FOMC’s two-day meeting in late September, Republican leaders of the House and Senate even sent Bernanke a letter saying that the Fed “should resist further extraordinary interventions in the U.S. economy,” an extraordinarily blatant attempt to apply political pressure to monetary policy.
But if anything, the case for extraordinary interventions was now even stronger, with economic conditions in the United States worsening as the eurozone crisis deepened. Fed staff knocked together another clever tool that would allow the bank to ease policy without all the Sturm und Drang that would come with a QE3 program. The means by which quantitative easing affects the economy is called the portfolio balance channel. When the Fed buys $600 billion in Treasury bonds, as it did in QE2, the investors who would otherwise have owned those bonds have to stuff that money into something else—corporate bonds, for example, or mortgage-backed securities or stocks. According to Fed thinking, wherever the money goes, it helps growth, either by making corporate and home mortgage borrowing cheaper or by boosting the stock market.
There was plenty of evidence that this was true—the stock market inevitably rallied after speeches or comments that suggested more bond buying was likely, for example. The success of the approach suggested an interesting possibility: If the Fed were to shift its portfolio into longer-term bonds and away from shorter-term debt, it might be able to lower long-term interest rates across the economy, encouraging business investment and mortgage borrowing. The action would have the effect of simultaneously raising short-term interest rates, but only negligibly, because the Fed had already committed to keeping them near zero. Theoretically, borrowing would be inexpensive in both the short and the long term.
It’s called twisting the yield curve, and a variation had been tried at the central bank in 1961, when it was called Operation Twist, a not terribly sly reference to the dance craze of the time. The Bernanke Fed, with its culture of seriousness, called the strategy a Maturity Extension Program. But to the media, Operation Twist, with its attendant possibility of Chubby Checker–based headline puns, was an irresistible way to describe the policy. In the Fed’s analysis, simply selling off $400 billion wort
h of bonds maturing in less than three years and buying $400 billion of bonds maturing in six to thirty years would a powerful boost for the U.S. economy—nearly as impactful as QE2 had been.
But because the Fed wasn’t creating any new money by buying additional bonds—and because the typical politician didn’t understand Operation Twist—the maneuver seemed less likely to draw the kind of counterproductive attacks that QE2 had. “Printing money” sounds scary. “Extending the duration of the Federal Reserve System Open Market portfolio” just sounds confusing to most people. It was, in a sense, a stealth form of quantitative easing—which was quite clear to the FOMC hawks. Richard Fisher, Narayana Kocherlakota, and Charles Plosser again dissented.
For the most part, though, public criticism was muted. Major world newspapers used the term “Operation Twist” in ninety-four different stories in the two weeks following the FOMC meeting. In the equivalent period after QE2 was announced, that term appeared in 158. Bernanke had spent his academic career arguing that central bankers, whether in the Great Depression or 1990s Japan, had the power to boost an ailing economy even in the lowest depths of a crisis. He retained that faith in his fifth year as Fed chairman—but he’d become savvier about how to use that power to get the economic benefits of easier money without suffering so many of the political costs.
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If the U.S. economy was recovering slowly from the trauma of the previous few years, the UK economy was recovering not at all. Inflation and unemployment were high, and the eurozone crisis seemed to send a new wave of panic washing over global financial markets every few months. “The euro-area crisis has had more dramatic moments, in which the ultimate resolution seems to be at hand only to be confounded by subsequent events, than there are episodes in The Killing,” Mervyn King said in his 2012 Mansion House speech, referring to the television police drama that had originated in Denmark and become a domestic hit on BBC Four. “And the Danes aren’t even members of the euro area.”