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Tuesday,
November 9, 2010 The
Fed and the Debased “Imperial Dollar”: Future Inflation, Timid Economic
Growth and Higher
Interest Rates Ahead "Under a paper money system, a determined government can always
generate higher spending and hence positive inflation." Ben
Bernanke, future Fed Chairman (in 2002) “My
thesis here is that cooperation between the monetary and fiscal authorities
in Japan could help solve the problems that each policymaker faces on its
own. Consider for example a tax cut for households and businesses that is
explicitly coupled with incremental BOJ purchases of government debt –
so that the tax cut is in effect financed by money creation. Moreover, assume
that the Bank of Japan has made a commitment, by announcing a price-level
target, to reflate the economy, so that much or all of the increase in the
money stock is viewed as permanent.” Ben
Bernanke, future Fed Chairman (in 2002) “The
Fed, in effect, is telling the markets not to worry about our fiscal
deficits, it will be the buyer of first and perhaps last resort. There is no
need - as with Charles Ponzi - to find an increasing amount of future
gullibles, they will just write the check themselves. I ask you: Has there
ever been a Ponzi scheme so brazen? There has not.” Bill Gross, PIMCO's managing director
On Wednesday, November 3rd, the Bernanke Fed
announced that it stands ready to resume money printing to stimulate the
economy through quantitative money easing, an euphemism for printing more
dollars. Indeed, it intends to buy $600-billion of longer-term Treasury
securities until the end of the second quarter of 2011, plus some $300
billion of reinvestments, on top of the some $1.75 trillion of various types
of securities, many of which were mortgage backed securities, that it has
added in 2009 to its balance sheet, currently standing at a total of $2.3
trillion. There could even be additional increases in newly printed money as
the Fed intends to "regularly review and adjust the program as needed
to best foster maximum employment and price stability." After the
election of fiscal conservatives on November 2nd, it seems that
printing money is the only instrument left for the Obama administration to
stimulate the economy. I fail to see, however, what is
“conservative” about that. Actively debasing a currency to
stimulate an economy used to be a Third-World economic recipe, —A
recipe for disaster. Now, the United States government feels that is the only
way to get out of the economic doldrums. But U.S.
economic problems are essentially structural in nature, and are due to a bad
housing mortgage policy, a bad industrial policy, a bad financial policy, a
bad fiscal policy, a bad foreign investment policy, too much entitlement
debt, severe demographic problems related to the aging baby-boomers,
and to very costly hegemonic wars abroad. Relying exclusively on monetary
quick fixes to correct them misses the mark and may have serious unintended
negative consequences down the road. In fact, it is
likely that in the long run, this extreme monetary policy risks exacerbating
rather than correcting the problems. Economic structural problems cannot be
corrected with monetary means. They rather require real economic solutions.
That means correcting the housing mortgage mess and devising an industrial
strategy, a fiscal strategy, and an investment strategy that can put the
economy back on its tracks of economic growth. But, for better
or worse, the Federal Reserve Board (Fed) seems to be the only branch of the
U.S. government left that can still function properly, i.e. that is not
caught in a permanent political gridlock. As a consequence, for the time
being at least, bankers are in charge of the U.S. economy. Since they are the
ones who created many of the current problems, this is not very reassuring. Let's remind
ourselves that the Fed is a semi-public, semi-private organization that has a
long history of creating financial asset price bubbles
in the U.S and around the world, essentially because the U.S. dollar is an
international key-currency widely used around the world and is an important
part of other central banks' official reserves. Thus, the real
danger is that the Fed will again overdo it and create unmanageable financial
and monetary bubbles in the coming years. —It did it in the past. It
did it in the late 1960's and early '70s, and we witnessed the same scenario
unfolding with the Greenspan Fed in the late 1990s, when excessive easy money
helped inflate the Internet and tech stock market bubble.
We saw this again in the early 2000s, when easy Fed money helped inflate the housing
bubble. And now, we're seeing it again with the Bernanke Fed.
As a general rule, a central bank should not push the monetary gas pedal to
the floor and be obliged to slam on the monetary brakes later, thus placing
the real economy on a roller-coaster of booms and busts. That is not the way
to run a large economy. But because of
the circumstances, the Fed may be at it again. This time it is busy creating
a massive bond
bubble, some important currency
misalignments and a massive gold and commodity
price bubble. We should also not forget that abnormally low
interest rates and lower bond yields increase the present value of pension
liabilities of most defined
benefit pension plans. Therefore, I
would not be surprised to see a pension crisis developing in the coming years under the current
Fed monetary policy. Of course, all of these bubbles are interrelated but
when they come crashing down, four or five years down the road, maybe sooner,
the economy may then be in worse shape than it is today. My most likely
scenario is for the Fed to keep the monetary gas pedal way down until the
2012 election, and then slam on the monetary brakes thereafter to salvage
what will be left of the imperial dollar. If so, this
could be a partial repeat of Japan's experience in mismanaging its economy in
the early 1990's until 2000, a period known as the lost decade. The current
Fed's monetary policy is to flood financial markets with liquidity, i.e.
newly created dollars, and, in the process, devalue the U.S. dollar, spur
American exports and prevent deflationary expectations from taking hold and
from making already high debt loads even heavier. For this, the Fed has been
engaged since 2009 in round after round of money creation and interest rate
reductions to the point of pushing short-term monetary rates close to zero
and keeping short-term real
rates negative. But if the economy is in a liquidity
trap, as it is fair to assume it is, although a central bank
can print all the money it wants, this is unlikely to stimulate the real
economy for very long. —This is like pushing on a string. Printing
money, if it is an emergency temporary measure, can help mitigate the effect
of having too much debt and debt-service costs relative to income, as is the
case today with many debtors in a debt liquidation
mode. However, if this becomes a feature of monetary policy for too long, it
can have disastrous consequences. In general,
it can be said that the Fed can manipulate short term interest rates by
artificially increasing demand for short term securities, but inflation
expectations are a big component of long term interest rates and are much
less influenced by the Fed. Therefore, if the Fed's intention of printing
large amounts of new money raises fears of future inflation, long term
interest rates may rise rather than fall, and this is bound to hurt long-term
productive investments. Moreover,
make no mistake, with globalized financial markets, a large chunk of the
newly created dollars is flowing out of the United States and is invested in
higher interest rate countries, pushing the dollar further down and these
countries' currencies further up. Of course, some of the newly created money
will immediately find its way in the stock market, but there is no certainty
that this will induce already stretched banks to increase their banking loans
to businesses. Another
consequence is this: The current outflow of U.S. dollars helps keep the
dollar exchange rate low, but when the Fed is forced to aggressively raise
interest rates, as it will inevitably be forced to do later on, the reverse
will happen and the U.S. dollar will likely overshoot and then become
overvalued. This is the case today with the Japanese yen which became unduly
strong when the Japanese
carry trade (too much cheap money invested abroad returns
home) collapsed. What counts for
most people, however, is that the Fed’s zero-interest rate policy has
not cured the structural
housing mortgage crisis, since home foreclosures are still
very high. The Fed now places most of its hopes on a currency devaluation,
which is the old trick of the “beggar thy
neighbor” policy, i.e. trying to export one country's
unemployment to its trading partners by devaluating the currency. This was a
form of protectionism
much relied upon during the 1929-39 Great Depression.
This may work for a while, at least as long as other countries can absorb
American exports without launching their own money printing process in order
to prevent an appreciation of their currencies. Indeed, is it likely that countries which see their
currencies being revalued by the Fed will remain passive? The Fed is
implicitly making the bet that these countries will not retaliate, and that
the international
dollar-based currency system will remain intact. But for how long?
Sooner or later, some central banks around the world will have no choice but
to impose capital controls
in order to slow down
the inflow of unwanted outside money and the onslaught of imported
inflation, and
prevent their exchanges rates from rising too high too fast. If they do, the
entire process of
economic globalization may begin to unravel. Meanwhile,
foreign central banks, for example, could accelerate their rush to dump the
U.S dollar and to accumulate gold and other more stable currencies such as
the euro, the Swiss franc, the British pound, the Canadian dollar and the
Australian dollar. China has already begun to do just that. The share of
dollar official reserves would then decline from about 60 percent
presently to perhaps less than 50 percent. That may signal the beginning of
the end for the “imperial dollar” which has dominated the
international monetary system since the Bretton
Woods conference
of 1944. This is to
be followed closely. _____________________________________ Rodrigue
Tremblay
is professor emeritus of economics at the University of Montreal and can be reached at rodrigue.tremblay@yahoo.com. He is the author of the book "The Code for Global Ethics" at: www.TheCodeForGlobalEthics.com/ The book “The
Code for Global Ethics, Ten Humanist Principles”,
by Dr. Rodrigue Tremblay, prefaced by Dr. Paul Kurtz, has just been released
by Prometheus Books. Please visit the book site at: www.TheCodeForGlobalEthics.com/ See it on Amazon
USA: See it on Amazon
Canada: See it on Amazon
UK: or, in Australia
at: Please ask your favorite bookstore and your local
library to order the book: The Code for Global Ethics, Ten
Humanist Principles, by Dr. Rodrigue Tremblay, prefaced by Dr.
Paul Kurtz, Prometheus Books, 2010, 300 p. ISBN: 978-1616141721. *****The French version of the book is also now
available. See: www.lecodepouruneethiqueglobale.com/ or on Amazon
Canada _____________________________________ Posted, Tuesday, November 9,
2010, at 5:30 am Email to a friend: http://www.TheNewAmericanEmpire.com/tremblay=1129.htm or click on Blog at: www.TheCodeForGlobalEthics.com Send
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