Hamish McRae: Our prosperity in the hands of one man

The head of the Fed is not an elected politician, yet he holds more power than the US President
Click to follow
The Independent Online

It is, if you think about it, extraordinary that power should reside in this place. The head of the Fed is not an elected politician yet, if this proposition is true, he holds more power than the US President. So power in our ever-more-global world is not political, nor military, nor industrial, nor scientific - it is financial. And the key choreographer of the world's financial markets is a man who has only one lever to pull. The head of the Fed, with his colleagues, simply sets US short-term interest rates.

So how far can this point about power be true? Insofar as it is, what does that say about the modern world? And what can we sensibly think about this new appointment?

As far as the first question is concerned, it depends what you mean by power. If you are talking about starting a war, that is a job for politicians. Ditto, creating new laws. If, on the other hand, you are talking about the practicalities of day-to-day life, I suppose the scientific and commercial communities influence us more than politicians. Sir Tim Berners-Lee, inventor of the world-wide web, has perhaps more than any other single individual changed the way we live and work. But that is not an example of consciously-exercised power: he just made an invention that helped to change the world.

Suppose, however, you are thinking about finance: what causes global recessions, what happens to the value of our savings, how easy we find it to get jobs and so on. Well, if those are the criteria, then the head of the Fed is almost certainly the most important single figure, despite his very narrow remit.

The reason is that an interest rate is the price of money. Since the US accounts for about one-third of the world economy, what happens to the price of money there sets off a chain reaction, first in the US itself and then in all the other economies around the world. Open the throttle by cutting US interest rates and the world economy starts to run a little faster; close the throttle by increasing rates and the world economy duly slows.

We have had a glimpse of this in Britain. How much the present run of US interest rate increases slows the world economy is still not clear, but it is very evident how much the rise in UK rates has slowed the UK one. Growth has halved this year against last year. House prices have stopped rising and retail sales are stagnant. Now Mervyn King, the governor of the Bank of England and chairman of its monetary committee, is not as powerful as the head of the Fed. The other committee members can out-vote him. But the power of interest rates is huge. Get them right and you create conditions where economies can prosper. Get them wrong and you can provoke a serious recession.

Dr Greenspan's stellar reputation lies in the widespread view that he shepherded the US economy through the world economic downturns of the early 1990s and 2000s with great skill. The US experienced only mild recessions each cycle, and sustained good low-inflationary growth for much of the past two decades.

Much of the world has benefited greatly from this strong US growth, in particular China and India, and also to some extent the UK. But the US growth has been achieved at a price of a widening current account deficit, now equivalent to 6 per cent of GDP, and most recently some evidence of rising inflation. My own judgement. for what it is worth, is that Dr Greenspan will be regarded more harshly by history than he is today. In particular, I think he will catch some of the blame for the excesses of the late 1990s boom for not increasing interest rates earlier to help contain it. I think he will also be judged to have been too tardy in increasing interest rates this cycle, encouraging the US housing boom and leaving his successor with some nasty decisions next year and beyond.

But that is just one view. What is pretty widely accepted is that decisions by Dr Greenspan have had enormous influence over the performance of the US economy. You do not win the confidence of the financial markets easily, and the fact he has done so has encouraged international investment in the US, which in turn has made possible its rapid growth. So the answer to the question - is the job really so powerful? - is pretty much yes.

What does this say about power in the world? Well, it says that the world economy is driven by private-sector financial and trading flows. China has sustained a growth rate in excess of 8 per cent for two decades, and is on course to pass the UK as the world's fourth largest economy this year. That is because it has attracted huge investment from the US and has a huge market in exporting to the States. China's power and influence has increased because it has grown so strongly.

Much the same point could be made about India, another huge beneficiary of globalisation. Its take-off has been more recent, but the world listens to India now to an extent that it did not a couple of decades ago.

One could go further and cite the rise in the influence the UK has within Europe. In 1992, the country was humiliated when sterling was forced out of the Exchange Rate Mechanism. But because it has grown more swiftly than Germany, France or Italy and has been much more successful in creating jobs, our European competitors are forced to acknowledge that there are elements in the UK economic model that they must adopt.

All this has happened because of the rising importance of flows of capital between countries. As recently as 1980, foreign-owned assets were equivalent to one quarter of world GDP; by 1990 they were half; and by 2000 they were as large as world GDP. Attract those funds and you do well; repulse them and you do badly. So politicians who follow market-friendly policies have countries that prosper, and vice versa. But the overall eye over these world markets - insofar as there is a single eye - is the chairman of the Fed.

So how will Ben Bernanke fare? What we can say is that he was the safest pair of hands available. He is a respected economist (like Mervyn King), which in this context is a recommendation. And the US markets initially liked the appointment, which is also good news.

The global outlook is less sunny. Since the early 1990s recession, there has been a long period of low-inflationary growth. That continues, but it is under strain. There will be a global downturn on Dr Bernanke's watch, and how he handles it will help determine whether our own prosperity continues for a while longer yet.