Banking on Bernanke

Picking a successor for Alan Greenspan, who led the Federal Reserve for 18 years, was an easy job for George Bush. There was really one man for the job.

Ben Bernanke, who officially takes over from the esteemed Mr Greenspan today, is a former economics professor, Fed governor and chairman of the White House's council of economic advisers. He has impeccable credentials for the job of heading the US central bank.

After a graduating in economics in 1975 from Harvard - where he won a prize for the best undergraduate thesis - he took a PhD at Massachussetts Institute of Technology in 1979.

He went on to become an associate professor of economics at Stanford University before going to Princeton where he stayed for 20 years, chairing the economics faculty from 1996.

A prolific writer, Mr Bernanke has written numerous books and scholarly articles, including A Crash Course for Central Bankers in the journal Foreign Policy; Essays on the Great Depression; and a textbook, Principles of Economics. Monetary policy - the role of the Fed - is his speciality.

In taking up his job, he has promised more of the same. To have done otherwise would have been foolish as most economists thought Mr Greenspan did a splendid job in managing crises, keeping inflation low and helping to raise US productivity.

Not that Mr Bernanke won't be doing some tweaking. We can expect him to introduce more explicit inflation targeting, along the lines of the system run by the Bank of England. He has made it clear he considers inflation of 1-2% to be a "comfort zone".

But perhaps the biggest trap Mr Bernanke could fall into would be to take an overly hard line on inflation to banish any lingering fears that he may be too soft on prices, concerns that date back to when he first joined the Fed as a governor in 2002.

At the time he made waves by voicing fears that the US could be facing the threat of deflation, defined as a sustained decline in price levels. Some economists criticised him for scaremongering by even raising the subject, triggering a spate of articles in the media on the subject.

That seems harsh as the topic was very much on everyone's minds at the time, and it was useful to get the perspective from someone at the Fed. But by raising the spectre of deflation, somehow he got stuck with probably an undeserved reputation as a soft touch on inflation.

In general, however, Mr Bernanke won many plaudits as a member of the Fed's open market committee - which sets interest rates for the world's biggest economy - and he takes the helm at a time when many economists hold quite an optimistic view of the global economy.

True, he will have to deal with a tricky legacy - a bubble in house prices and big twin deficits on trade and the budget, those dreaded "global imbalances" that so vex the IMF and other financial experts.

Last week Rachel Lomax, deputy governor of the Bank of England, warned that the US trade deficit and other large global imbalances could have "significant impact on economic activity".

The fear is that these imbalances will work themselves out in a worst-case scenario through a collapse of the dollar.

Laura Tyson, once part of Bill Clinton's economic team, believes the dollar needs to come down by about a third for the mammoth trade gap to shrink. As long as the dollar comes down in an orderly manner, the world can sleep easy.

But in common with many US economic officials, Mr Bernanke does not think that the current account deficit - the widest measure of the trade gap - is America's fault.

He blames other countries, especially in Asia but also in Europe, for having an excess of savings that they deposit in the US looking for returns. He has called this a "global savings glut".

The solution, as US policy makers have argued since the Reagan era, is for foreigners to go out and spend more, and specifically buy US goods - a course of action that would soak up the US pool of red ink.

Few of the great and the good meeting at the Swiss resort of Davos for the 2006 World Economic Forum foresaw such a scenario. Even Ms Tyson, who believes the dollar is overvalued, thinks 2006 will be like 2005 - "another Goldilocks kind of year", in which the global economy is not too hot or too cold, but just right.

The optimists may well be right, in which case Mr Bernanke will have a considerable grace period before a crisis hits.

Mr Greenspan, in contrast, did not have to wait long before he faced his baptism of fire. Within weeks of taking over in October 1987, he had to contend with the collapse of the stock market.

Mr Bernanke will be hoping that he will have a bit longer than a few weeks to settle in before unpleasant things hit the fan. But at some point a crisis will break, whether it be the long-feared slide of the dollar or something else.

Only then will the world be able to judge whether Mr Bernanke is Mr Greenspan's worthy successor.