That was fast ….
Only a few days ago, so it seems, it took about $1.25 to buy a euro. Now it takes closer to $1.45 (it was more earlier today, but the dollar subsequently rallied). And — as Macro Man notes — the dollar’s move pales relative to the recent slide in the pound. Not so long ago a pound bought 1.5 euros. Now it buys a euro and change. The Anglo-Saxon currencies haven’t had a good two week run.
Both the US and the UK had housing and finance centric economies. Both have significant external deficits. And both are inclined to use monetary and fiscal policy aggressively to combat a downturn.
But with global trade collapsing, the euro’s rise can not be all that comfortable for members of the eurozone. It isn’t clear that any one wants a stronger currency right now. Currencies though are relative prices — and can go up or down amid a global contraction. In theory, everyone could ease monetary policy equally without changing the relative value of any currencies. In practice things rarely work out as neatly.
Dr. Krugman, I would assume, hopes that the euro’s rise puts more pressure on Germany to join a coordinated European fiscal stimulus — with good reason. Germany’s export machine relies on global and European demand. That demand is falling (watch Russian imports for example). And if the euro’s rally is sustained, Germany will soon face an additional headwind. So too will the less competitive members of the eurozone. They are in an even more difficult position if Germany doesn’t lead a coordinated European reflation.
Four other thoughts:
1) Until fairly recently, all the European currencies tended to move in tandem against the dollar. That meant their cross-rates were stable. And it meant that the euro wasn’t as strong as it seemed. The euro was strong against the dollar and the yen, but not against the pound, the Swedish krona, the Norwegian krona and similar currencies. Right now the euro is rising against all the smaller European currencies — not just against the dollar.
2) Japan is starting too worry about yen strength, not surprising. Renewed intervention seems like a possibility if the yen continues to rise. That shouldn’t be a surprise. Japan tends to intervene heavily when the interest different between the yen and dollar goes away, reducing private market demand for dollars.
3) China has to be pleased by the euro’s rally. Dollar strength translated into RMB strength — and a rising RMB when Chinese exports were slowing (and likely now falling) made Chinese policy makers uncomfortable. There was even talk of moving to a real basket peg — which would have meant that RMB would depreciate against the dollar when the dollar was strong. But I rather doubt that China now wants to appreciate against the dollar to offset the dollar’s renewed weakness against the euro. Right now China is happy to see the dollar and thus the RMB weaken …
4) Central banks have been big buyers of the pound over the past few years. Reserves were growing, and the pound’s share was rising. Central banks liked its yield — and the fact that it an easy alternative to both the dollar and the euro. By my count, central bank inflows often were large enough to cover the UK’s current account deficit. Central banks reserves are shooting up, but if they “rebalance” their portfolios they should be big buyers of pounds now — as they need to hold more pounds to keep the pound’s share of their portfolio up as the pound’s value slides.
I’ll be interested to see if they do so — or if they start to view the pound as Europe’s equivalent of an Agency bond …
Interesting points on pound. I too wonder what are UK’s problems and what will be the solutions. I remembered remotely that UK’s national debt is only about 8% of GDP. UK should be in a relatively good position to spend money, don’t you think? I thought EUD’s rally is only temporary. Once German agree on fiscal spending, EUD would drop again.
Not so long ago a pound “bought” 1.5 euros.
In this blog I have read a top economists, like Brad, put very well grounded arguments to predict the relative values of major currencies, as world economic order tries to find a new equilibrium. But behind all this I think what the major currencies are trying to do is – devalue their currencies just a little bit.
If there were a switch to devalue the currencies in a controlled manner by 20%, simultaneously, we would not have to go through these gyrations to the bottom. Imagine, if the dollar were to devalue by 20% or so, all the house prices would stabilize (nominal terms). Banks would start lending again and we could resume our consumption the way we like it. Other currencies could come down just that much.
Only that after breaking the gold connection, there is no obvious way to devalue the currency. One can only devise clever ways of increasing money supply, velocity etc and just hope that the desired implied devaluation hits 20%. It also keeps other countries guessing. If somebody thinks that the relative values of currencies will be starkly different in future, they are ignoring that currency structures are tied to physical structures like factories, businesses, people skills etc. The world and society can change it, but not overnight. The other countries would be forced to devalue their currencies commensurately.
This is how the world looks to a non-economist.
i need to do a better job of proofing …
According to MacroMan a massive EUR buying caused the recent spike.
I think we are at very early stages of the demise of the USD as global reserve currency. The lack of alternative will make this process extremely slow and complicated.
The hidden problems in European banking system will cause much agony for a long time. AIG bailout must be evaluated in this context.So a sustained EUR strenghtening is very unlikely in my view.
But i have a respect for prudent bankers at ECB. FED looks like casino operator in a western movie.
According to MacroMan a massive EUR buying by chinese authorities caused the recent spike.
Demise of USD is strong wording, unless you predict run-away inflation in just the US. I hope it does not mean US trade will disappear or USD will reduce to 10 cents of its value. Sure, USD might need to be devalued in a controlled manner and when it does, other currencies would devalue because otherwise they lose their competitiveness. They have no option but to devalue their currencies by one means or another. Or… they shut their borders to trade. Is it not inevitable that Euro must devalue as well eventually?
I have not yet read any reputed economist talk about the imaginary scenarios like run-away inflation in US. Or does that only happen in less sophisticated economies like Zimbabwe? I only read about run-away inflation on buy-gold-now type websites, but tend not to believe them because none of the top economists like Roubini, Shiller, Setser, Stiglitz, Krugman, Rogoff, Thoma etc even talk about it.
Brad, can you please enlighten us why uncontrolled inflation can happen and why it would not? Why could they not control inflation in the past, in other countries?
Some necessary deflation of the currency once in a century does not have to mean demise of the currency.
the euro zone stability as against the lesser countries’ currencies is partly to do with the size of the bloc. ireland is painfully aware that if there was still such a thing as an irish punt (pound) it could be following the icelandic krona trajectory by now. the united states had greenspan, but ireland had depressed eurozone interest rates appropriate to germany and france, and this served to exaggerate the property boom in much the same way.
perhaps the tide will run towards blocs, instead of dollar reserves as insurance against currency collapse, some form of regional bonding. north america, eurozone, south america, islamic middle east, far east, and africa – might form their own versions of eurozones or currency defence alliances ?
similarly, if california was a country – would the californian dollar be under heavy pressure now ?
i get the impression that things, as brad’s headline suggests, even when predicted correctly, surprise the forecasters by the speed at which they happen.
competitive devaluation is forecast. perhaps that game is already underway ? expect bluff and threat to be part of the game.
in the 14th century philip de valois king of france, after the disaster of the battle of crecy in 1347, fell back on devaluing the coinage.
what bernanke threatens in pixels the king did in metals. my account (by barbara w tuchman) calls this taxation by subterfuge. it is in effect a confiscatory tax on savers ? ?
she notes that devaluing the coinage disrupts prices, rents, debts, and credit – and is regularly disastrous.
kings used to raise taxes to go to war. the bush regime lowered taxes and went to war. now there is a black hole that swallows the price of an iraq war or thereabouts ($700 billion?) in regular ’stimulus packages.’
of course things are different now – or are they ? the nobles screwed up at crecy – but the peasants picked up the bill. the king could devalue the national currency – but how can bernanke devalue a currency that transcends borders, without resorting to deglobalising protectionist measures ? how do you devalue in an open world of floating, but manipulated, fiat currencies ?
i am peering into a financial fog of matters that i do not understand -
but i stuck with 40 dollar oil.
i am sticking with deflation until there is strong evidence of the opposite trend arising. when o p e c cuts back and oil falls the same day . . . a very strong trend is in place.
i feel that ‘this time’ things will unfold with great speed when they do happen.
and i stick with urging those who specialise in the policies and choices of china, not to lose sight of japan. i suggested that japan and toyota and sony would be feeling the pressure from yen appreciation. two days later a statement comes out. o k – it is japan and honda. can’t win them all.
japan is a compliant u s ally. but japan has different memories of the last couple of decades from the rest of us. that can change.
if the game is to devalue the coinage to pay for the war – and it usually is – how many countries can play that game ? and who can tell japan to sit on the sidelines ?
and when everyone is finished – i suspect that the helicopters of the fiat nations will still not have filled the black hole at the centre of the financial galaxy.
Here are the latest seasonally-adjusted money supply statistics just released at 4:30pm this evening:
M1: 37.6% growth rate in last 13 weeks
M2: 13.9% growth rate in last 13 weeks
Howard Richman
http://www.tradeandtaxes.blogspot.com
Don’t forget that the “yellow” metal international currency otherwise known as Gold has also done extremely well with today’s spot maeket close at $860 per ounce. The Gold price has completely decoupled from the Oil price.
Every fiat paper currency in world history from the Chinese dynasties to the Roman Empire eventually has led to financial collapse. The US Dollar will also collapse to its intrinsic value of the paper it is printed on.
Remember if it acts like money then Gold is “real money”. An ounce of Gold can be exchanged or used to purchase anywhere in the world. Across Asia, it is actually easier to trade Gold than in the United States. The ignored U.S. Constitution actually states that the nation’s money shall be backed by Gold precisely because Gold is “real money”.
The Federal Reserve with its fiat paper dollars printed by Wall Street banks should be eliminated in favor of a “hard currency” backed by Gold as specified by the U.S. Constitution.
[...] Brad Setser spells it out a little more concretely….. Only a few days ago, so it seems, it took about $1.25 to buy a euro. Now it takes closer to $1.45 (it was more earlier today, but the dollar subsequently rallied). And — as Macro Man notes — the dollar’s move pales relative to the recent slide in the pound. Not so long ago a pound bought 1.5 euros. Now it buys a euro and change. The Anglo-Saxon currencies haven’t had a good two week run. [...]
I apologise for the off-topic post but this is important. A new NYT article has some data about just how outrageous compensation on Wall St was in the boom years.. Goldman paid more than $1B in bonuses to just 50 people. Why are these shameless individuals not returning their ill-gotten bonuses?
http://www.nytimes.com/2008/12/18/business/18pay.html
On Wall Street, Bonuses, Not Profits, Were Real
While top executives received the biggest bonuses, what is striking is how many employees throughout the ranks took home large paychecks. On Wall Street, the first goal was to make “a buck” — a million dollars. More than 100 people in Merrill’s bond unit alone broke the million-dollar mark in 2006. Goldman Sachs paid more than $20 million apiece to more than 50 people that year, according to a person familiar with the matter.
Brad,
How interesting that the euro is going up vs. the dollar, but the other European currencies are not moving in tandem. Bernanke’s latest moves are causing a flight away from the dollar by private investors. Now is the time when foreign Central Banks will again step up their dollar purchases.
Japan and Germany will lose market share during the current depression unless their governments intervene in world currency markets. Their economists and politicians are not ideological free traders. They understand mercantilism. They know that they just have three choices:
1. Allow their industries to lose market share and go bankrupt with American industries.
2. Start insisting on balanced trade.
3. Resume manipulating their currencies to weaken them vs. the dollar so that they can keep their market share.
I would prefer the second choice, but I expect Japan and Germany will do the third. They have practiced mercantilism in the past, and are likely to beggar-the-United States again in the future. If so, the fall of the dollar vs. the yen and euro will be temporary. The United States will continue to commit economic suicide without being joined by Japan and Germany.
Howard
“UK’s national debt is only about 8% of GDP. ”
Maybe but private debt is very high, 120% or more maybe 150% og GNP, like USA.
DJC – The ignored U.S. Constitution actually states that the nation’s money shall be backed by Gold precisely because Gold is “real money”.
Here is what the constitution says about money:
Article I, section 8: The Congress shall have Power To… coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
Article I, section 10: No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.
It does not say that the nation’s money has to be gold.
http://www.archives.gov/exhibits/charters/constitution_transcript.html
a few observations from my side of the atlantic:
the uk economy is much more open than the us economy. i.e. currency depreciation (esp against the euro – far and away our biggest trade partner) has a much bigger impact on aggregate demand.
the pound’s significant fall in value seems to be driven largely by interest rate expectations so far. long-dated gilts have rallied throughout the last 2-3 weeks. it is not a panic a la iceland (in which case gilts would have sold off). this is important for the usa insofar as the pound can be considered a leading indicator for the dollar (i.e. same fundamentals, but without the reserve currency status and everything that goes with it).
nonetheless there is real genuine concern at a disorderly collapse of the pound, i.e. one that would significantly raise the cost of capital in the uk, incl for the uk govt. the boe in its latest meeting specifically alluded to this.
although there is zero appetite for the pound to join the euro, euro interest rates still influence the uk’s. i.e. the uk cannot allow its interest rate to diverge too far from the ecb’s because of the risk of destabilising the eur/gbp exchange rate.
having said that, it very clearly is the policy of the boe / uk govt to engineer a rapid but orderly devaluation of the pound. this is the easiest mechanism for heading off deflation and addressing our current account deficit (which btw will only get worse as our main “export” was financial services).
although there is zero public appetite for joining the euro (in fact the pound’s devaluation is simply demonstrating the benefit of independence right now), this could change rapidly if the pounds fall turns into an icelandic-style capitulation. in that case a commitment to join the euro (which would only be credible if opinion polls backed it) would be a powerful weapon for stabilising the exchange rate.
the rise of the euro is not quite as devastating for germany as some assume. germany’s main trading partners are other eurozone countries. yes it cares about the pound and dollar. but it does not need to worry about terms of trade with its main trading partners (this “fixed” exchange rate is very analogous to usa vs china). i seem to recollect that 1.50 exchange rate started squeals from paris (but not so much from berlin) last year.
in any case, the eurozone’s problem is more than just german fiscal pigheadedness. the ecb (which is headed by a frenchman) is (a) totally independent by international treaty, (b) has an explicit and unambiguous inflation mandate, (c) is notorious for its caution and gradualism. that isn’t to say that eurozone rates won’t eventually get cut to zero, but don’t expect it to happen this side of the summer holidays. and don’t expect qe until the fed has led the way and proven its worth. even if the germans are brought onside, greater fiscal expansion is likely to give the ecb even more pause for thought.
as i have mentioned in previous posts, the eu is much less enamored of global free trade than the usa. its model is gradualists – i.e. start with your immediate neighbours, set up a cosy but manageable club with extreme conditionality and common interest, and build from there. the eu has threatened to impose trade sanctions on china before. i expect to see a lot more threats in 2009 as (a) this is something that all eurozone countries can agree upon, and (b) devaluing the euro is not an option thanks to the ecb.
btw brad, your maths tests stink!
I think the UK is undergoing a crisis of credibility. The authorities told a good story about golden fiscal rules and inflation targets, but when the constraints started to bind, they were relaxed. Of course the authorities try to avoid embarassment by claiming wisdom in a crisis, but the markets are sceptical.
British net government debt to GDP ratio, by the way, is about 40%, but this excludes public sector pension liabilities and off-balance sheet infrastructure lease schemes, not to mention the sizable contingent liabilities that have been taken on during the financial crisis.
2) Japan is starting too worry about yen strength, not surprising. Renewed intervention seems like a possibility if the yen continues to rise. That shouldn’t be a surprise. Japan tends to intervene heavily when the interest different between the yen and dollar goes away, reducing private market demand for dollars.
They should be strongly discouraged from this tactic. The yen is still substantially undervalued and continues to contribute to Detroit’s woes..
Crash the dollar all you want: it’ll make Obama’s task of employing americans all the easier…
I could very well see the EU buying USD to protect zee Ger-I mean, EU exports… ja ja.
Please don’t use harsh words like a USD crash, it may be just a bit of devaluation. Isn’t it the rule of world – the savers are fooled into thinking that their savings will brings fruits later. But has there ever been an era in history when for some reason or another a currency has not been devalued significantly? Just accept a bit of inflation/devaluation (whatever you call it) and the outlook will appear bright once more.
Now if USD is being devalued, Euro supporters just cannot let their currency rise. Can the Europeans not devalue their currency in a socially just manner? Is there a creative way to print more money and compensate the savers (cash and debt holders) justly? Perhaps there is a simpler way. But then again this might be the first time the world has faced a problem like this – devalue your currency but do it in just manner.
Who really cares about the Yen, CAD, AUD bunch; will they not just follow. You think they really have a choice?
on 9/28/08:
FOMC swapped $240B with ECB.
& 1€ = $1.46170
so who really is ‘you-know-who’?
is it who you really ‘think’ it is?
or is it rather ‘he-who-must-not-be-named’?
“would the californian dollar be under heavy pressure now ?”
calikrona, here we come…
“but japan has different memories of the last couple of decades from the rest of us.”
maybe more like 63 years?
(beautiful essay there gillies, cheers)
Brad – were you posting on CR last night about the IMF FSAP of the US? If so, I’ll leave a trail of crumbs on the CR board.
I suspect the outcome will be blander than could be expected, for instance, if the FSAP team go to the SEC and ask all about Madoff, what are they going to learn?
C
A good sign that the Fed is creating inflationary expectations, which is what we need at the zero bound. Of course, we can have too much of a good thing…
@ bena gyerek:
Great comment there.
Could you please expand on this point a little bit?
euro interest rates still influence the uk’s. i.e. the uk cannot allow its interest rate to diverge too far from the ecb’s because of the risk of destabilising the eur/gbp exchange rate.
PS: you can type your comment up in MS Word, then refresh the screen on this page, paste it on. If you lose the comment you can Ctrl-C Ctrl-V again from your word doc.
wd:
see below a comment taken from the recently released minutes to the last rate cut meeting. the boe cut rates 100bp to 2.00%, but had considered a (second consecutive) 150bp cut:
“There was a risk that going further could cause an excessive fall in the exchange rate. There was also a risk that an unexpectedly large cut could undermine confidence in the economy more widely.”
release of these comments unsurprisingly sent the pound lower.
as i mentioned in my first post, the issue is an orderly vs disorderly (panicky) devaluation of the pound, and by implication that the pound’s devaluation should not cause the govt’s cost of borrowing to skyrocket. currently the 30y gilt is trading around 4% (which i personally think is nuts).
the reason i mention the euro is that it is our main trading partner (about 60% of uk imports / exports i think), so the eur/gbp rate is the most relevant benchmark for our terms of trade. moreover, the uk is a member of the eu (but outside the eurozone), so there are also political considerations for the uk govt – i.e. it won’t want to be accused of trying to beggar its european neighbours.
here are some other useful data about the uk to get things in context:
imports/gdp: 23%
ca balance: -3%
gross debt/gdp: 400%
household debt / disposable income: 165%
govt debt/gdp: 40% (pls see rebeleconomist’s important caveat above)
govt primary deficit: -4.9% (some forecasts have it at -8%!)
as you can see, we are in as big a pickle as the usa as far as indebtedness goes. although the uk government has a relatively small existing debt stock, it has a huge structural budget deficit (sound familiar?).
in a lot of ways the uk economy is like a microcosm of the us economy, except for a few important differences: (a) we are much more exposed to exports so devaluation is a very handy policy tool, (b) we cannot print reserve currency to repay our debts so confidence in the pound (or at least foreigners’ willingness to buy gilts) is paramount, (c) we started with much higher interest rates than the fed so monetary policy has had more leverage, (d) our massive exposure to the financial services “industry” (about 15% of gdp off the top of my head) means both gdp and exports will suffer really badly in the short term.
like the usa, our government borrows almost exclusively in its own currency (there are a minority of inflation indexed and euro gilts). so it can always inflate its way out of a debt default in the worst case. our banking system does have very significant short term money market foreign currency liabilities, but in the worst case these can be segregated by the govt upon nationalisation of the banks and allowed to default.
btw, if you are interested in reading more about the uk, i recommend robert peston at the bbc and willem buiter at the ft.
bena gyerek:
in a lot of ways the uk economy is like a microcosm of the us economy, except for a few important differences: (a) we are much more exposed to exports so devaluation is a very handy policy tool, (b) we cannot print reserve currency to repay our debts so confidence in the pound (or at least foreigners’ willingness to buy gilts) is paramount, (c) we started with much higher interest rates than the fed so monetary policy has had more leverage, (d) our massive exposure to the financial services “industry” (about 15% of gdp off the top of my head) means both gdp and exports will suffer really badly in the short term.
But we are also rather more exposed to inflation on a falling currency via imports, something which I think is already showing up in the fact that inflation has only fallen to 4.1 per cent primarily because of the rise in price of imported food.
The government and the BoE may want to be cavalier about sterling’s depreciation but I wonder how much longer they can ignore it as a constraint, especially given how much the government is going to be borrowing next year.
@bena gyerek:
Thanks a lot for your elaboration. I think I now understand that there’s a link between the GBP and EUR interest rates/exchange rate. Here’re my thoughts on GBP devaluation:
It’s hard to think that the GBP’s strength comes from ‘hard work’. I think it comes from the fact that foreign countries that export to the UK must be accumulating GBP in their forex reserve to strengthen their exports. Secondly they must be using that strength to improve the utility of borrowing from London banks at low interest rates for local credit expansion.
I’m not clear how there can be a disorderly devaluation of GBP. There might be a lot of foreign currency debt that is denominated in GBP in other countries. A weakening GBP would lead to a run on foreign currency debt in those countries. That brings balance of payments problems for those people.
One of my recent insights, mostly from reading Brad, is that we’re no longer in an oil-dollar world. The dollar is sustained by employment levels in emerging markets that are tied to US exports. That reasoning should also apply to the GBP.
Secondly the dollar reserve currency status helps countries with large dollar reserves to increase their bargaining power in trade worldwide. This second effect might not apply to the GBP.
But effects #1 and #2 above should mean that there can’t be a panic devaluation of the GBP.
If you have data on the total foreign currency debt that is denominated in GBP that would be great for analysis; and the share of GBP in world forex reserves.
There’s around $ 2 trillion of FCD worldwide, and the short term maturity component of that is around $1 trillion (October data from Brad’s blog and other sources).
Finally, I don’t think the foreign exchange rate of a particular currency is in any way derived from the ‘government’s books’. Legal tender currencies can’t be valued in terms of foreign currency the way you might value a stock price based on a company’s books. This distinction is critical because it shows you how the current crisis is different from the Great Depression days, which were basically gold standard days.
Currency movements have also much to do with expected economic development. So it is natural that the dollar falls against the euro not only because of differing interest rates (0.25% vs. 2.5%) but also because of the expectation that the US economy will underperform Euroland. As a consequence the US government will print money to start a fiscal stimulus, this will mid-term lead to much higher inflation than in Euroland (where the inflation busting credential of the ECB/Bundesbank are intact). Considering this you have to sell dollar assets and go into euro assets.
For Germany in particualar this is a pretty difficult environment as a rising currency will depress its exports, the main driver of GDP growth there. As a consequence Germany will suffer no less from a recession, though it will be lucky partly as the non-German stimuli will also help them. In a sense the Germans are free riders now, but then, it is not them who created the mess in the first place.
bena gyerek
many thanks for your comments, they are quite insightful.
I too have lost my share of comments b/c of the math test. Sometimes the question changes while you are typing. That does though have the healthy effect of discouraging overly long comments. It also is a surprisingly effective anti-spam device, which makes my life much easier …
one trick is to save a copy of the comment before formally posting (ctrl-c the text) and that way you have a backup .. word also works.
@bena/brad:
It looks to me that there’s a race on to make investments in emerging markets infrastructure. I’d be quite thankful for an opinion on the macro-economics behind this.
There’s a global demand slump and at the same time you’ve always had a shortage of infrastructure in countries like China and India. For instance you have cities like Bangalore which have developed with narrow roads, frequent interruptions of power supply, and woefully inadequate mass transport systems. Even as the boom in IT services etc has been brought to a kneel, the prospects of the infrastructure sector are getting brighter and brighter.
This should lead to import demand, mainly for construction and earth-moving equipment, power plants, civil engineering equipment, public transport vehicles, etc. Volvo is the traditional leader in that segment. It should also lead to financing opportunities, since infrastructure financing is largely through debt.
You have to notice that infrastructure in emerging markets is largely a positive NPV project. The projects are executed through various public-private partnership models. One of the models is build-own-lease-transfer, for instance.
There’s a huge difference between India and China on this. China can achieve much more rapid infrastructure development since private property rights aren’t as strong. At the same time FDI laws and capital controls are much more liberal in India and that spurs greater foreign investment and exports to that sector.
Illustrating the “Intellectual Bankruptcy” of the Federal Reserve, even Businessweek admits that Bernanke’s failed economic strategy rests on re-inflating another Financial Bubble to bailout the economy from the deflated Housing Bubble. It won’t work. Greenspan inflated the Housing bubble to mitigate the impact from the collapsed Dot-com bubble. Even Greenspan was smart enough to recognize that you can’t reinflate a collapsed bubble so he inflated the larger Housing bubble. There isn’t another asset class big enough to inflate to prevent US economic collapse. Bernanke will attempt to inflate the money supply until we have an inflationary depression that was experienced by Germany during the 1930’s. No “real industrial economic” wealth is being created from Bernanke monetary money printing to bailout corrupt Wall Street banksters.
http://www.businessweek.com/magazine/content/08_52/b4114022505333.htm?chan=top+news_top+news+index+-+temp_news+%2B+analysis
In a Dec. 17 research note, Yardeni wrote: “After one bubble bursts, the only way to get out of the resulting recession, and to avoid a depression, is to create another bubble.”
What’s more, starting in early 2009, the Fed will pump money into markets for student, auto, credit-card, and small-business loans in hopes of helping those parts of the economy. All told, the Fed’s assets—a measure of how much the Fed has lent, directly and indirectly—could go as high as $5 trillion, says Ed Yardeni of Yardeni Research. That’s up from $2.2 trillion now. And the range of assets the Fed is permitted to acquire in an emergency is almost unlimited. “It could buy a herd of cattle in Texas if it so desired,” says Paul Ashworth, senior economist in the Toronto office of consultant Capital Economics.
The central bank is running unacceptable risks of losses by itself and ultimately by taxpayers while propping up an unsustainable reliance on debt. “It’s 100% wrong. It’s going to make the situation worse,” says Peter Schiff of Euro Pacific Capital, a brokerage in Darien, Conn. “In the short run, it does postpone some of the pain, but the economy is going to be in worse shape a year from now. Eventually we will have hyperinflation, where the dollar loses almost all its value.”
@ DJC:
What you’ve quoted above comes from a misreading of the Mises classical theory.
1) Credit expansion causes imbalanced current accounts, and not the other way round. Absent runs on gold reserves of banks/governments, modern deleveraging doesn’t necessarily lead to immediate re balancing of current accounts.
2) Returning to pure commodity money, such as gold, will only bring back the medieval problems of gold wars, and create more disasters. Besides, it’s not practically feasible to return to gold.
3) The increased credit availability from the Fed will flow out of the US, largely to inflate bubbles in foreign countries.
Compagnie Financiere Edmond de Rothschild, the French fund- management unit of privately held bank LCF Rothschild Group, and Bank of China will begin an asset-management and private-banking venture to sell Rothschild’s financial products through the 10,800 branches of the Chinese lender, according to a Sept. 18 statement announcing the investment.
http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=a2hZdL5hcipQ
Not just UK, there s this »coalition of wise guys« who think they can think first…
…but then manage to produce “bollocks” later.
The central bank is running unacceptable risks of losses by itself and ultimately by taxpayers while propping up an unsustainable reliance on debt. “It’s 100% wrong. It’s going to make the situation worse,” says Peter Schiff of Euro Pacific Capital, a brokerage in Darien, Conn. “In the short run, it does postpone some of the pain, but the economy is going to be in worse shape a year from now. Eventually we will have hyperinflation, where the dollar loses almost all its value.”
Makes sense to me.
While I agree with Bena Gyerek that the exchange value of the pound matters, I think that its depreciation against the euro is less of a constraint than against the dollar. We tend to compete with Europe, so a weak pound against the euro helps, but import commodities priced in dollars.
Also, I would not dismiss the importance of sterling as a reserve currency to the UK economy. The last COFER showed sterling as the third largest reserve currency. Obviously, sterling accounts for a far smaller share of foreign exchange reserves than the dollar or euro, but then the UK economy is smaller too. Because there are not many convertible currencies issued by major economies, many countries hold some sterling in their reserves, especially commonwealth countries. I doubt whether their interests count much in deciding UK monetary policy though!
@ Reformer: I thought you would be smart enough to look at the real point. Peter Schiff is long gold futures and he’s been advising people to buy gold. Arguing for a dollar collapse is supposed to scare folks into buying gold. That bet is against the fed, and I wouldn’t make it. However for a rich, lazy cat who wants to do absolutely nothing for life, gold is a good investment.
i don’t normally get this many responses to my posts..
brit – yes, agreed re inflation, though i suspect some surprise inflation may actually be a policy objective
wd – the reason for the pound’s excessive strength in recent years was to do with a kind of “dutch disease” connected with the financial services sector. london exported financial services. the huge profits made (and the playboy speculative bubble that went with them) created strong inflationary pressures in the london area. this resulted in much higher interest rates than suited the rest of the uk economy (there was always an interest rate premium over the eurozone) and therefore an overvalued currency that blighted our other exporting sectors, notably manufacturing.
a disorderly collapse of the pound is a risk because the uk economy has a humungous amount of debt (4x gdp). it is way more than our government could possibly shoulder on its own – i.e. if the recession gets bad our government cannot rescue the entire economy. and yet the credit crunch in the uk is becoming so severe that our government is now resorting to guaranteeing new bank loans to the private sector. another round of bank recaps (aka fullscale nationalisation) is also possible. when governments get into fiscal trouble they either default or debase their currency (debasement = devaluation / inflation). debasement is the more attractive option for the uk, as foreign currency liabilities are mainly held within the international banking sector and could be segregated and allowed to default if need be. but the risk is that foreign investors will realise the govt’s / boe’s ultimate strategy is currency debasement, in which case they will dump the pound and all gbp-denominated assets, including gilts.
re – i don’t think commodities being priced in dollars is at all relevant, unless you think “framing effects” are important. an oil forward contract can easily be hedged with a eur/usd forward. recent years have shown that when the dollar falls against eur, it also falls against oil etc, and vice versa. a lot of that is because commodity prices are driven as much (indeed more) by demand from non-dollar countries than from the usa.
i would be interested if you could reproduce the cofer data on gbp share of global reserves, including whether there is a rising or falling trend in its share.
bena gyerek,
I cannot post a graph to show a trend here of course, but the sterling proportion of reserves for which the currency allocation was reported to the IMF grew from 2.7% in 1999Q1 to 4.7% in 2008Q2. The proportion might have gone slightly higher when sterling was at its strongest, but not much. Basically, sterling gained as a reserve currency when the introduction of the euro reduced the range of suitable currencies.
You can peruse the latest COFER report yourself at:
http://www.imf.org/external/np/sta/cofer/eng/cofer.pdf
I am not sure that a “collapse” of the exchange value of sterling from here is likely; I dare say that the UK is already looking like a cheap place to manufacture for the European market (eg Toyota, Nissan etc). But any attempt at inflationary repudiation of Britain’s debts would be interesting. Just about the last claim to economic responsibility the government has is the inflation targeting regime. Let that go completely (in my opinion it has already slipped a bit), presumably under protest from the BoE, and the government would not have a shred of economic credibility left.
Haven’t had the time to look at some of the other comments, pretty sure rebeleconomist and a few of the euro crowd would have offered insightful responses. Thought to give my 2 cents worth, ok, penny worth.
The pound was pretty much unsustainable at the levels at which it was at previously. However glittery the City, the rest of British economy wasn’t quite that glittery. The expansion of credit via unrealistic inflation of house prices means its problems are at least as bad as the americans, of course on the high end there are foreign investors to take part of the fall.
As for rebalancing, well, maybe via the euro route instead, either way, there’s no avoiding volatility or losses.
rebeleconomist – thanks. that data is interesting. the pound has a bigger role than i expected, though it is still the case i think that relative to gdp the pound’s share of reserves is underweighted even compared with the euro.
i agree that the risk of a total collapse of sterling is small, but it’s a bit like what economists like to call the “peso risk” – i.e. a small probability of a major fall in value that doesn’t appear in historic performance, but nonetheless causes a currency to be relatively undervalued. imo, market fears of a pound collapse are now an additional factor weighing on the currency’s value.
bena gyerek,
I think you are correct, but not significantly so – the emu share of world reserves is about 27%, and the UK’s GDP is about a fifth of emu GDP.
However, I think the future is clear, which is one reason why I thought that the UK should have seriously considered negotiating joining emu last year, when we could do so from a relatively strong position. Sadly, it seems to be the case that, when the British economy is doing well, we believe we can do without Europe. I have always envisaged that the UK will attempt to join emu for the worst of reasons – to jump mortgage rates lower when the markets are demanding increasing interest rates to lend to us. Just as we tried with the ERM!
Sorry if this parochial issue is of little interest to usual readers!