American monetary policy has been getting a lot of mainstream press of late due to the falling dollar. This is unusal, because monetary policy is geneally not something that the average 'current events follower' would care about. But that seems to have changed a bit of late. Now, I'm not an economist - nor did I stay in a Holiday Inn Express last night - but I have been doing some reading of late due to the increasing oil prices and decreasing dollar, and what I read is not exactly encouraging.
Let's start with the following articles:
The Dollar's Demise
It does not help when the chairman of your central bank, Alan Greenspan, ..., has said the day before that the dollar seems likely to fall: “Given the size of the current-account deficit, a diminished appetite for adding to dollar balances must occur at some point,” were his exact words. The foreign-exchange market immediately decided that it was sated, and the dollar fell to another record low against the euro.
At the heart of the central banks’ calculations is a trade-off: intervening to keep your currency down can be costly, but it is good for exports. Though the costs of intervention are hard to quantify, they are potentially big. Because the domestic money supply is expanded—those dollars must be paid for with something—it can cause inflation (though this can be neutralised through “sterilisation”, ie, bond sales). But the big potential cost is in amassing a huge stash of dollars with precious little exit strategy. Quite simply, Asian central banks now own too many of them to exit en masse, for their exit would cause the dollar to crash and American interest rates to soar, which would cause huge losses on their holdings of Treasuries.
And what will then happen to the dollar? It is hard to imagine its hegemony remaining unchallenged when so many will have lost so much. And doubly so given that America has abused the dollar’s reserve-currency role so egregiously that its finances now look more like those of a banana republic than an economic superpower.
Folks - that's The Economist, as reputable and high-end as objective media comes. And they used a term like 'banana republic'.
Economic `Armageddon' Predicted
Stephen Roach, the chief economist at investment banking giant Morgan Stanley, has a public reputation for being bearish. But you should hear what he's saying in private. Roach met select groups of fund managers downtown last week, including a group at Fidelity. His prediction: America has no better than a 10 percent chance of avoiding economic ``armageddon.''
In a nutshell, Roach's argument is that America's record trade deficit means the dollar will keep falling. To keep foreigners buying T-bills and prevent a resulting rise in inflation, Federal Reserve Chairman Alan Greenspan will be forced to raise interest rates further and faster than he wants. The result: U.S. consumers, who are in debt up to their eyeballs, will get pounded. Less a case of ``Armageddon,'' maybe, than of a ``Perfect Storm.'' To finance its current account deficit with the rest of the world, he said, America has to import $2.6 billion in cash. Every working day. That is an amazing 80 percent of the entire world's net savings. Sustainable? Hardly.
Yes, that's the chief economist at Morgan Stanley - long time bastion of American capitalism.
Being John Snow
The market scoffed at Snow. As he spoke, the dollar plunged to a new record low against the euro. Snow's performance worsened during question time. When an audience member had the temerity to ask why Snow persisted in discussing the strong dollar policy while the greenback was plummeting, he simply responded "because it's our policy." Challenged again, he reiterated: "The policy is the policy."
Snow is the Treasury Secretary.
Economic Crisis a Question of When, Not If
"So if you ask the question do we look like Argentina, the answer is a whole lot more than anyone is quite willing to admit at this point. We've become a banana republic."
Krugman is an Professor of Economics at Princeton.
Wow - the falling dollar looks to hold a lot of problems. My understanding is that there is two general schools of thought about the falling $:
1. It is good for the economy in the short term - because a weak $ and stronger foreign currencies mean that our trade deficit goes down. Suddenly, foreign products are more expensive, domestic products are cheaper which means that, on whole, we import less and export more. Because of the $'s weakness, Europe and Asia want to buy our products, not sell their products to us in $. What does that mean - well it could mean lower trade deficits, more exports, and more jobs here in the states.
2. It is bad for the economy, period - because a weak $ means higher inflation (because there are not as many cheap, foreign products in the market). Higher inflation means either prices are going up across the board, or the Fed has to raise intrest rates to control inflation - which means that debt becomes more and more expensive - which kills US households because, in general, we live in so much debt, and kills US lendors due to the potential of more defaults due to a sluggish economy paired with expensive debt.
An overriding concern in the Good/Bad debate is that the $ is propped up by so much foreign investment. As one of the articles pointed out - 2.6 billion per DAY. That's an unbelieveable rate. What happens if China decides to stop buying US dollars or US Treasuries? Or - worse - start selling. Of coure, the counter argument is that they can't. Europe and especially Asia has so much invested in the US that to see the dollar tank or Treasuries tank would mean huge losses for them. So they hold on, or buy more...but at what point does the United States become beholden to those foreign investors?
Maybe now? "One China" Policy Stabilizes Asia-Pacific Region, Powell Says
This is pretty scary stuff overall. There are so many variables - but a weak dollar presents a MYRIAD of long-term problems. These are real issues that are going to have to be addressed sooner or later. Unfortunately, our short-term driven "leaders" (I call them that only for lack of a better word) refuse to take the bold steps it takes to actually improve the fundamentals affecting our monetary policy. (I direct you back to my 8:42am post of October 18, 2004 - Fiscal Gap Estimated as high as $72 Trillion.) Until then - we creep every closer to the brink of an economic disaster, and the only way to avoid it is allow foreign investors to prop up the US dollar - which presents it's own frightening questions.