Boiled down, the criticisms of the Fed come down to two: its policies are leading to hyperinflation; and they are 'beggar my neighbour', in consequence, if not intention.Commodity inflation "My view has been that the Fed needs to prevent a repeat of Japan's deflationary experience of the 1990s, but that it also needs to watch commodity prices as an early indicator that it's gone far enough in that objective. In terms of concrete advice, I would worry about the potential for the policy to do more harm than good if it results in the price of oil moving above $90 a barrel. And we're uncomfortably close to that point already."
The first of these criticisms is not just wrong, but weird. The essence of the contemporary monetary system is creation of money, out of nothing, by private banks' often foolish lending. Why is such privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe? When banks will not lend and the broad money supply is barely growing, that is just what it should be doing.
The hysterics then add that it is impossible to shrink the Fed's balance sheet fast enough to prevent excessive monetary expansion. That is also nonsense. If the economy took off, nothing would be easier. Indeed, the Fed explained precisely what it would do in its monetary report to Congress last July. If the worst came to the worst, it could just raise reserve requirements. Since many of its critics believe in 100 per cent reserve banking, why should they object to a move in that direction?
Now turn to the argument that the Fed is deliberately weakening the dollar. Any moderately aware person knows that the Fed’s mandate does not include the external value of the dollar. Those governments that have piled up an extra $6,8000bn in foreign reserves since January 2000, much of it in dollars, are consenting adults. Not only did no one ask China, the foremost example, to add the huge sum of $2,400bn to its reserves, but many strongly asked it not to do so.
What is right isn't important for now. What is politically expedient is. Americans want a quick cure for their country's economic difficulties and want to devalue the dollar to achieve it. If it could force China to increase its currency value, then the Yen, Euro, and all the others would go up in tandem. The US, one fourth of the global economy, could export its way out of its problem.Raghu Rajan: The Big Blink - "World growth is likely to remain subdued over the next few years, with industrial countries struggling to repair household and government balance sheets, and emerging markets weaning themselves off of industrial-country demand. As this clean-up from the Great Recession continues, one thing is clear: the source of global demand in the future will be the billions of consumers in Africa, China, and India. But it will take time to activate that demand..."
But the others won't follow this program. China cannot move up its currency value too much or it would trigger hot money outflow, collapsing its property market and the banking system along with it. China is between a rock and a hard place. It is trying to achieve a soft landing of its property market by incremental tightening steps while the currency appreciation expectation keeps the hot money from leaving. This combination may support a multiyear gradual adjustment, giving the banking system time to raise capital...
It seems that nobody wants to appreciate. Most major economies will do something to keep their currencies down. That is checkmate for the US. Without the devaluation benefit on rising exports, QE just leads to inflation, first through rising oil prices. The American people are suffering from declining housing prices and high unemployment. If the gasoline price doubles, the country may not be stable. How would the elite react? Probably more of the same.
The world is heading towards high inflation and political instability. It's only a matter of time before there is another global crisis. The first sign would be a collapsing treasury market. The Fed is controlling the yield curve through its QE program. But, it is irrational for other investors to play this game. The only reason to stay in is that the Fed won't let the market fall. But, the underlying value is evaporating with rising money supply and the inflationary consequences. When all the investors realize this, they will run for the exits and the Fed won't be able to stop the stampede. If it prints enough money to take over the whole market, the people with freshly minted dollars would surely want to convert their money into other assets. The dollar would collapse too.
The world seems on course for another crisis in 2012. The same people who caused the last crisis are still in charge. They'll get us into another. Iceland is sending its former prime minister to court for causing the banking crisis. A worse fate awaits the people who are causing the next crisis.
Over the next decade, growth in this kind of developing-country demand will help offset the slow growth of demand in industrial countries. But the process cannot be rushed. Unfortunately, with high levels of unemployment in industrial countries, policymakers want to do something – anything – to increase growth fast. The aggressive policies that they are following, however, could jeopardize the process of adjustment...The coming right-wing front on monetary policy - "I was interested in the Audit the Federal Reserve amendment... But I understood it as the first step in promoting a more transparent, accountable Federal Reserve that is less dominated by the interests of regional bankers and the financial sector, not as a first step toward abolishing it. What a bizarre time for monetary policy and the conservative right... I do wonder how this battle inside the right will play out over the next few years, years in which the Federal Reserve actually being able to hit its inflation target would make the difference between the prospects of a generation being economically productive or a generation lost to hysteresis and isolated from functioning labor and economic markets."
Emerging markets are worried because they believe that the Fed's ultra-aggressive monetary policy will have little effect in expanding US domestic demand. Instead, it will shift demand towards US producers, much as direct foreign-exchange intervention would. In other words, quantitative easing seems to be as effective a method of depreciating the dollar as selling it in currency markets would be.
Because they know that it will take time for domestic demand to pick up, emerging markets are unwilling to risk a collapse in exports to the US by allowing their currencies to strengthen against the dollar too quickly. They are resisting appreciation through foreign-exchange intervention and capital controls. As a result, we might not see steady growth of demand in emerging markets. Instead, excess liquidity and fresh asset bubbles could emerge in the world’s financial and housing markets, impeding, if not torpedoing, growth.
In the ongoing showdown over currencies, who will blink first? The US (and other industrial countries) could argue that it has high levels of unemployment and should be free to adopt policies that boost growth, even at the expense of growth in emerging markets. These countries, in turn, could argue that even very poor US households are much better off than the average emerging-market household.
Rather than bickering about who has the stronger case, it would be better if all sides compromised – if everyone blinked simultaneously. The US should dial back its aggressive monetary policy, focusing on repairing its own economy's structural problems, while emerging markets should respond by allowing their exchange rates to appreciate steadily, thereby facilitating the growth of domestic demand. Is it too much to hope that the G-20 can achieve such a commonsensical compromise?
This was addressed by Keynes’s proposal for capital controls (to guard against capital flight) and, more imaginatively, to create a new international reserve asset that he called "bancor" (short for "bank money"), which would replace gold as the ultimate reserve asset of the system. Gold would remain as a reference point for the value of bancor, thus limiting the capacity of the ICB to create credit – which seems similar to Mr Zoellick’s idea. Keynes's famous description of the gold standard as a "barbarous relic" does not quite capture his opinion of the metal, which he thought would be useful as a constitutional monarch but disastrous as a despot.Keynes, Global Imbalances, and International Monetary Reform, Today - "Moving decisively towards promoting the use of SDRs would reduce the need for countries to run current account surpluses to accumulate dollar reserves. Concomitantly, it would also help to reduce the 'exorbitant privilege' of reserve-issuers and distribute the seignorage from reserve creation more equitably, promote a more symmetric adjustment mechanism, make the IMF a more genuine lender of last resort and reduce the risk of instability caused by switches between reserve currencies. Of course the appeal of the SDR would be materially enhanced if it were transformed into an asset that can be held by the private sector, not central banks alone... And it would open the road to a bargain with China... Just as the first Bretton Woods system rested on a 'grand bargain' between the US and Britain, so a new Bretton Woods would require an agreement between the leading surplus and the leading deficit country. The challenge to the statesmanship of the US and China is to strike one."
It was not to be: the Keynes plan was vetoed by the US at Bretton Woods in 1944 and the mighty dollar took bancor’s place as the world’s main reserve asset. Today, the difficulties in moving to an international currency reserve system are formidable. But the rationale for the Chinese proposal is clear: collective insurance is cheaper than self-insurance.
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posted by Fizz at 5:06 PM on November 10, 2010