Does The Federal Reserve Know
What It Is Doing?
KINGSTON, NY, 5 November 2010 — In an effort to stimulate the economy, the Federal Reserve is attempting to drive exceedingly low interest rates yet lower by purchasing $600 billion more of Treasury debt by June of next year. The idea is that by making credit more plentiful, businesses and individuals will be able to borrow on easier terms, thus helping to revive investment and consumer spending. The Fed’s decision is puzzling. Interest rates already are very low. Even if the Fed succeeds in reducing them a bit more, the stimulative effect is likely to be small. In fact, the Fed’s low interest rate policy denies interest income to retirees and reduces consumer spending by more than it increases it via credit expansion.In all likelihood, the Fed’s purchases will be offset in whole or part by reductions in purchases by other parties. The interest rate on US Treasuries is already too low to compensate for the potential rise in inflation and decline in the dollar’s exchange value. The US is a heavily indebted country with financing needs for massive deficits. Debt monetization, with its inflationary implications, might be the only way for the US government to cover its red ink. Indeed, the Fed’s explanation of its bond purchases as a stimulative policy might be cover for what is in reality a policy of financing the federal budget deficit with newly created money.Such suspicions have increased the concerns about the values of dollar-denominated assets. Since the Fed announced its bond purchases on November 3, the dollar has dropped sharply against other currencies and precious metals. If this response continues, purchases of Treasury bonds, except for the Fed’s, would dry up. If foreign holders of US assets decided that the yield is insufficient to cover the dollar’s loss of purchasing power, they are likely not only to stop buying more but also to begin selling off their stocks of Treasuries and other dollar assets and converting the dollars into other currencies and precious metals. Such a sell-off would more than offset the Fed’s purchases. Faced with a declining dollar and a rising interest rate as Treasury prices fell in the sell-off, the Fed would lose control. Perhaps the Fed has been overcome by hubris, but it is hard to imagine that the Fed has not considered that too much money creation will undermine the Treasuries that it is trying to support. I suspect that the Fed is relying on other countries to protect their exports to the US by printing their currencies and purchasing US dollars in order to prevent rises in the dollar values of their currencies. In other words, the Fed believes that by inflating the dollar, it can force other countries to inflate also.Such a policy could temporarily succeed. However, as countries printed money in order to protect their exports, the adverse effects on their economies would exceed the value of preserving their exports to the US. At that point dollar flight would ensue, and the dollar would cease to be the world’s reserve currency.The dollar’s loss of the reserve currency role would free the world of the burdens imposed by US economic and foreign policies. The wars and economic bullying would stop, because the US would have no way of financing its foreign aggressions or imposing economic penalties on countries that do not comply with its dictates. The US economy cannot be revived unless the budget and trade deficits can be reduced. This would require ending Washington’s hegemonic wars and bringing the offshored jobs back to the US. The military/security complex will not want the wars stopped, and the multinational US corporations will not want offshoring stopped. Therefore, the crisis imposed by the American imbalances will continue as long as the world tolerates it. When the world ceases to tolerate it, the crisis will be America’s alone, and the crisis will devour the country. From many foreign perspectives, the silver lining is the end of the Empire.
What It Is Doing?
KINGSTON, NY, 5 November 2010 — In an effort to stimulate the economy, the Federal Reserve is attempting to drive exceedingly low interest rates yet lower by purchasing $600 billion more of Treasury debt by June of next year. The idea is that by making credit more plentiful, businesses and individuals will be able to borrow on easier terms, thus helping to revive investment and consumer spending. The Fed’s decision is puzzling. Interest rates already are very low. Even if the Fed succeeds in reducing them a bit more, the stimulative effect is likely to be small. In fact, the Fed’s low interest rate policy denies interest income to retirees and reduces consumer spending by more than it increases it via credit expansion.In all likelihood, the Fed’s purchases will be offset in whole or part by reductions in purchases by other parties. The interest rate on US Treasuries is already too low to compensate for the potential rise in inflation and decline in the dollar’s exchange value. The US is a heavily indebted country with financing needs for massive deficits. Debt monetization, with its inflationary implications, might be the only way for the US government to cover its red ink. Indeed, the Fed’s explanation of its bond purchases as a stimulative policy might be cover for what is in reality a policy of financing the federal budget deficit with newly created money.Such suspicions have increased the concerns about the values of dollar-denominated assets. Since the Fed announced its bond purchases on November 3, the dollar has dropped sharply against other currencies and precious metals. If this response continues, purchases of Treasury bonds, except for the Fed’s, would dry up. If foreign holders of US assets decided that the yield is insufficient to cover the dollar’s loss of purchasing power, they are likely not only to stop buying more but also to begin selling off their stocks of Treasuries and other dollar assets and converting the dollars into other currencies and precious metals. Such a sell-off would more than offset the Fed’s purchases. Faced with a declining dollar and a rising interest rate as Treasury prices fell in the sell-off, the Fed would lose control. Perhaps the Fed has been overcome by hubris, but it is hard to imagine that the Fed has not considered that too much money creation will undermine the Treasuries that it is trying to support. I suspect that the Fed is relying on other countries to protect their exports to the US by printing their currencies and purchasing US dollars in order to prevent rises in the dollar values of their currencies. In other words, the Fed believes that by inflating the dollar, it can force other countries to inflate also.Such a policy could temporarily succeed. However, as countries printed money in order to protect their exports, the adverse effects on their economies would exceed the value of preserving their exports to the US. At that point dollar flight would ensue, and the dollar would cease to be the world’s reserve currency.The dollar’s loss of the reserve currency role would free the world of the burdens imposed by US economic and foreign policies. The wars and economic bullying would stop, because the US would have no way of financing its foreign aggressions or imposing economic penalties on countries that do not comply with its dictates. The US economy cannot be revived unless the budget and trade deficits can be reduced. This would require ending Washington’s hegemonic wars and bringing the offshored jobs back to the US. The military/security complex will not want the wars stopped, and the multinational US corporations will not want offshoring stopped. Therefore, the crisis imposed by the American imbalances will continue as long as the world tolerates it. When the world ceases to tolerate it, the crisis will be America’s alone, and the crisis will devour the country. From many foreign perspectives, the silver lining is the end of the Empire.
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