Apparently it was the topic de jour at the IMF annual meetings this past weekend. Though framed as a "currency war" by some IMF participants, Martin Wolf explains it is really about two rebalancing acts in the global economy:
The first is internal rebalancing – a return to reliance on private demand in advanced countries and retrenchment of the fiscal deficits that opened in the crisis. The second is external rebalancing – greater reliance on net exports by the US and some other advanced countries and on domestic demand by some emerging countries, notably China.
As noted by Wolf, it just so happens that both of these rebalancing acts can be addressed by one policy response: aggressive monetary easing by the Fed. That now seems to be happening in the form of QE 2. The Fed, though, is not purposely trying to tackle both rebalancing acts. Rather, it is simply trying to shore up aggregate demand (AD) in the U.S. economy and spur an economic recovery. Doing so would solve the first rebalancing act. Now because the Fed is a monetary superpower, its attempts to shore up U.S. AD will get exported to many other countries in the world, particularly those those dollar bloc countries that pegged in some form to the U.S. dollar and do so in a manner that maintains external competitiveness. It is these same countries that are a key part of the second rebalancing act. They are not pleased by this development as it implies either (1) letting their currencies appreciate against the dollar and losing some external competitiveness or (2) intervening in foreign exchange markets to prevent this appreciation from happening and allowing a large expansion of their domestic money supplies. Either way, the second rebalancing act will occur: dollar block countries' currencies will appreciate or their domestic prices will increase.
For the dollar block countries they see a "currency war" and want to fight back. For the Fed it sees weakening AD and is determined to stabilize it. So who will win this global economic showdown at the OK Corral? Martin Wolf says there is no doubt to the eventual outcome of this exchange:
The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world.
Why should QE increase AD? QE involves giving bond holders cash in exchange for bonds. Since those holders regard bonds as part of their SAVINGS, i.e. not money to be spent in current consumption, most of the money will just get dumped in bank accounts (as many of us predicted two years ago). And wouldn’t you know it - bank reserves have shot up to an all time record level. I fell over backwards with non-surprise when that happened.
ReplyDeleteOf course some of the money will seek out other forms of savings, i.e. other assets. And wouldn’t you know it: the stock market is doing well, at least much better than the unemployed folk in Main Street. I’m still lying on the floor with non-surprise.
I’d rather sail in the Titanic than in the QEII.
Thank you David Beckworth, for the great article. I am glad you brought it to my attention. That being said, Martin Wolf is way off.
ReplyDeleteThe Fed does not have unlimited ammo. OMG. These so-called experts have no idea what they are talking about.
I know it was taken out of context, but: No there will not be an easy surrender to the dollar on our own terms.
If that is what he thinks, he has no idea the tectonic shifts that are occurring.