The editorial board of the Wall St. Journal has revealed great insight into why many political economies throughout the world are experiencing problems with price stability, native currencies and inflation. The answer is easy to see: the U.S. Federal Reserve continues to maintain its policy of easy money (quantitative easing) as exit strategy for an economy that is weak on ‘demand.’ The problem is that many nations, not just China peg their currencies to the dollar. Consequently, we are creating housing bubbles in Asia and massive exporting of inflation to other dollar friendly nations. This is a political problem of the first order. The editorial board of the Journal explained how.
The U.S. Federal Reserve insists on ‘going its own parochial, self interested way on monetary policy and exchange rates.’ What they’ve ignored is the ‘price of the global medium of economic exchange.’ Namely the U.S. Dollar.
The consequences are both political and commercial. Brazil now has double digit bond yields and a surge of Capital flowing into its Treasury. Asia continues with a massive real estate bubble, the Yen in Japan is roiling its local politics and the Euro-Dollar rate continues to fluctuate wildly. All this spells great political trouble for the United States.
Robert Mundell, the Nobel Prize winner Macroeconomist reveals that the last few months have been the most violent in the entire currency history of 3,000 years. The instability created by violent fluctuations in the Euro-Dollar rate means that companies cannot maintain stable planning schedules or anticipate real time costs, all which leads to misallocation of resources and wasted investments. According to the editorial board, the daily amount of currency trading is over $4 Trillion.
The greatest danger now is protectionism in the form of devaluation of a nations currency so as to improve its own terms of trade. We are currently witnessing such moves throughout the Asian bloc. With a depreciation of any exchange comes a rise in price. Charles Kinleberger wrote of our contemporary situation in ‘The World In Depression’. If tariffs meet with protectionism along with currency devaluation, the result is mutual destruction. The kind we saw in the 1930’s which stimulated the rise of Fascism. We are not far off from this analogy now!
The current canard that China revalue its Yuan to offset the U.S. trade deficit is another intellectual error that can profoundly effect price levels and inflation quickly.
THE ROOT OF THE PROBLEM IS INTELLECTUAL!
The U.S. Federal Reserve along with Congress, continue to maintain that U.S. monetary policy does not affect the rest of the World. This bespeaks great ignorance of our contemporary financial global market. Many developing nations peg their money to the U.S. Dollar to attract investment and create a climate of stability. In so doing, such nations are subcontracting their monetary policy to the Federal Reserve.
Chairman Ben Bernanke’s Fed has focused exclusively on the U.S. domestic economy primarily through quantitative easing and expansion of the Federal Reserve Balance sheet which is uses to purchase Treasury Bills. But the reflation of the U.S. economy through quantitative easing has troubling consequences as we are witnessing in exchange rates and commodities.
“The larger threat here is to the dollar’s role as a reserve currency and to the overall world monetary system. The two worst monetary disruptions in the last 100 years occurred when the world’s leading economic powers abdicated a leadership role. The 1930’s Kindleberger book titled above describes how the weakened British were no longer able to lead and the American’s were still unwilling.” In the 1970’s U.S. Treasury Secretary John Connally and President Nixon leaned on a very compliant Federal Reserve Chairman Arthur Burns to help blow up the Bretton Woods post war system of fixed exchange rates. The great inflation of the 70’s followed. As U.S. Treasury Secretary John Connally famously told Europeans concerned about exchange rate fluctuations, ‘the dollar its our currency, but your problem.’ The task of economic leaders is to head these financial and political problems off before they produce a crisis akin to the 1930’s.
“WHEN EVERY COUNTRY TURNED TO PROTECT ITS NATIONAL PRIVATE INTEREST, THE WORLD PUBLIC INTEREST WENT DOWN THE DRAIN, AND WITH IT THE PRIVATE INTERESTS OF ALL.”