Showing posts with label ge2. Show all posts
Showing posts with label ge2. Show all posts

Saturday 6 November 2010

The age of the dollar is drawing to a close

The age of the dollar is drawing to a close
Currency competition is the only way to fix the world economy, says Jeremy Warner.

By Jeremy Warner
Published: 7:04AM GMT 05 Nov 2010


Dollar hegemony was itself a major cause of both the imbalances and the crisis Photo: BLOOMBERG

Right from the start of the financial crisis, it was apparent that one of its biggest long-term casualties would be the mighty dollar, and with it, very possibly, American economic hegemony. The process would take time – possibly a decade or more – but the starting gun had been fired.

At next week's meeting in Seoul of the G20's leaders, there will be no last rites – this hopelessly unwieldy exercise in global government wouldn't recognise a corpse if stood before it in a coffin – but it seems clear that this tragedy is already approaching its denouement.

To understand why, you have to go back to the origins of the credit crunch, which lay in the giant trade and capital imbalances that have long ruled the world economy. Over the past 20 years, the globe has become divided in highly dangerous ways into surplus and deficit nations: those that produced a surplus of goods and savings, and those that borrowed the savings to buy the goods.

It's a strange, Alice in Wonderland world that sees one of the planet's richest economies borrowing from one of the poorest to pay for goods way beyond the reach of the people actually producing them. But that process, in effect, came to define the relationship between America and China. The resulting credit-fuelled glut in productive capacity was almost bound to end in a corrective global recession, even without the unsustainable real-estate bubble that the excess of savings also produced. And sure enough, that's exactly what happened.

When politicians see a problem, especially one on this scale, they feel obliged to regulate it. But so far, they've been unable to make headway. This is mainly because the surplus nations are jealous defenders of their essentially mercantilist economic models. Exporting to the deficit nations has served them well, and they are reluctant to change.

Ironically, one effect of the policies adopted to fight the downturn has been to reinforce the imbalances. Fiscal and monetary stimulus in the US is sucking in imports at near-record levels. The fresh dose of quantitative easing announced this week by the Federal Reserve will only turn up the heat further.

What can be done? China won't accept the currency appreciation that might, in time, reduce the imbalances, for that would undermine the competitiveness of its export industries. In any case, it probably wouldn't do the trick: surplus nations have a habit of maintaining competitiveness even in the face of an appreciating currency.
Unable to tackle the problem through currency reform, the US has turned instead to the idea of measures to limit the imbalances directly, through monitoring nations' current accounts. This has already gained some traction with the G20, which has agreed to assess the proposal ahead of the meeting in Seoul. As a way of defusing hot-headed calls in the US for the imposition of import tariffs, the idea is very much to be welcomed, as a trade war would be a disaster for all concerned. China, for one, has embraced the concept with evident relief.

Unfortunately, the limits as proposed would be highly unlikely to solve the underlying problem. Similar rules have failed hopelessly to maintain fiscal discipline in the eurozone. What chance for a global equivalent on trade? With or without sanctions, the limits would be manipulated to death. And even if they weren't, the proposed 4 per cent cap on surpluses and deficits would only marginally affect the worst offenders: for a big economy, a trade gap of 4 per cent of GDP is still a massive number, easily capable of creating unsafe flows of surplus savings.


No, globally imposed regulation, even if it could rise above lowest-common-denominator impotence, is unlikely to solve the problem, although it might possibly stop it getting significantly worse. But what would certainly fix things would be the dollar's demise as the global reserve currency of choice.

As we now know, dollar hegemony was itself a major cause of both the imbalances and the crisis, for it allowed more or less unbounded borrowing by the US from the rest of the world, at very favourable rates. As long as the US remained far and away the world's dominant economy, a global system based on the dollar still made some sense. But America has squandered this advantage on credit-fuelled spending; with the developing world expected to represent more than half of the global economy within five years, dollar hegemony no longer makes any sense.

The rest of the world is now openly questioning the merits of a global currency whose value is governed by America's perceived domestic needs, while the growth that once underpinned confidence in its ability to repay its debts has never looked more fragile.

Already, there are calls for alternatives. Unwilling to wait for one, the world's central banks are beginning to diversify their currency reserves. This, in turn, will eventually exert its own form of market discipline on the US, whose ability to soak the rest of the world by issuing ever more greenbacks will be correspondingly harmed.

These are seismic changes, of a type not seen for a generation or more. I hate to end with a cliché, but we do indeed live in interesting times.


http://www.telegraph.co.uk/finance/comment/jeremy-warner/8111918/The-age-of-the-dollar-is-drawing-to-a-close.html

UK economy in danger of being sucked into Ben Bernanke's great inflation

UK economy in danger of being sucked into Ben Bernanke's great inflation

Markets were in party mood on Thursday. But traders' hangovers this morning have less to do with celebrating a market discounting strong economic growth and a lot more to do with equities being seen as a refuge.

By Damian Reece, Head of Business
Published: 6:00AM GMT 05 Nov 2010

Ben Bernanke hopes the $600bn cash injection will re-float the sunken American property market.

The great inflation is under way, its source is the US but we are close to being sucked in too.
Investors are fleeing into equities as a hedge against inflation. The US is now being run by experimental economics, a $600bn (£372bn) experiment to be precise as Ben Bernanke, chairman of the US Federal Reserve, hopes to re-float the sunken American property market and punish savers, transferring wealth to debtors through negative real interest rates.

Bernanke's hoped for by-product of reopening the liquidity floodgates is to stimulate every American's favourite past time – spending. The risk that much of the cash that the Fed is pumping into the US economy will simply be hoarded by banks to reduce their own leverage has been dismissed by Bernanke, a decision which could be his biggest mistake.

This is the man that missed the significance of America's deteriorating mortgage scene in 2006, believing firmly that toxicity had been diluted through the credit markets.

Now he wants inflation higher and interest rates lower to provide a massive one-off refinancing for US householders still in negative equity. By reflating property prices, and keeping the heat under equity prices, he is hoping to trigger a "wealth" effect on main street.

The other constituency in deep debt is the government, running an enormous deficit. President Barack Obama, left helpless by the mid-term elections, will also receive a bail-out through quantitative easing because, as with US households, he will inflate his way out of debt as the ratio of deficit to GDP improves. And if the numbers look better then the less pressure there is to cut spending and raise taxes to sort the deficit.

Our own quantitative easing habit has been put on hold but an official Bank rate of 0.5pc is keeping the inflationary burners alight. As if the Bank of England's Monetary Policy Committee needed any encouragement, George Osborne yesterday reminded the Treasury Select Committee that his tight fiscal policy allowed "flexibility" in monetary policy.

I doubt flexibility to increase rates to head off inflation is what he had in mind when he said that. Flexible monetary policy is fine, as long is its flexible downwards and consistently inflationary. As if on cue, Simon Ward of Henderson Global Investors yesterday predicted CPI would hit 4pc by early 2011.

Britain's saving grace is Osborne's fiscal consolidation plan and supply side reform to boost employment and new business formation.

But the risk is that increasing inflation will dampen the Chancellor's ardour to pursue his much needed reforms, leaving us without the policies enacted to deliver sustainable growth and with prices out of control.


http://www.telegraph.co.uk/finance/comment/damianreece/8111484/UK-economy-in-danger-of-being-sucked-into-Ben-Bernankes-great-inflation.html

Friday 5 November 2010

Fed Gets Aggressive After Months of Holding Back

ECONOMIC SCENE


By DAVID LEONHARDT


Tim Shaffer/Reuters
Fed Chairman Ben Bernanke.


Matthew Staver/Bloomberg News
Thomas Hoenig, president of the Kansas City Fed.

Readers' Comments

Readers shared their thoughts on this article.
One focused on the risks of the Fed’s taking more action to help the economy. This camp — known as the hawks, because of their vigilance against inflation — worried that the Fed could be sowing the seeds of future inflation and that any further action might cause global investors to panic.
Another camp — the doves — argued instead that the Fed had not done enough: inflation remained near zero, and unemployment near a 30-year high.
In the middle were Ben Bernanke and other top Fed officials, who struggled to make up their minds about who was correct. For months, they came down closer to the hawks and did little to help the economy. On Wednesday, they effectively acknowledged that they had made the wrong choice.
The risks of inaction have turned out to be the real problem.
The recovery has not been as strong as the Fed forecast. Businesses became more cautious about hiring after the European debt crisis in the spring. State governments began cutting workers around the same time, and the flow of federal stimulus money began to slow. Since May, the economy has lost 400,000 jobs.
Now — six months later, with Congress unlikely to spend more — the Fed is getting more aggressive. (And, yes, the idea that the doves are the advocates for aggression is indeed a bit odd.) Having long ago reduced its benchmark short-term interest rate to zero, the Fed will again begin buying bonds, as it did last year, to reduce long-term interest rates, like those on mortgages. Lower rates typically lead to more borrowing and spending by households and businesses.
Of course, the risks of taking action have not gone away. The new policy could eventually cause inflation to spike. All else equal, a policy that encourages more spending will cause prices to rise. And if investors begin to think that a dollar tomorrow will be worth much less than one today, they may refuse to lend money at low interest rates, undercutting the whole point of the bond purchases. Separately, the Fed, like any bond buyer, could end up losing money on the purchases, worsening the federal budget deficit.
What’s striking about the last six months, however, is how much more accurate the doves’ diagnosis of the economy has looked than the hawks’.
Early this year, for example, Thomas Hoenig, president of the Kansas City Fed and probably the most prominent hawk, gave a speech in Washington warning about the risks of an overheated economy and inflation. Mr. Hoenig suggested that the kind of severe inflation that the United States experienced in the 1970s or even that Germany did in the 1920s was a real possibility.
When he gave the speech, annual inflation was 2.7 percent. Today, it’s 1.1 percent.
The doves, on the other hand, pointed out that recoveries from financial crises tended to be weak because consumers and businesses were slow to resume spending. Around the world over the last century, the typical crisis caused the jobless rate to rise for almost five years, according to research by the economists Carmen Reinhart and Kenneth Rogoff. By that timetable, the unemployment rate would rise for a year and a half more.
Perhaps the clearest case for more action came from within the Fed itself. In June, an economist at the San Francisco Fed published a report analyzing how aggressive monetary policy should be, based on past policy and on the current levels of unemployment and inflation.
As a benchmark, it looked at the Fed’s effective interest rate, taking into account the actual short-term rate as well as any bond purchases to reduce long-term rates. Because the short-term rate was zero and the Fed bought bonds in 2009, the report judged the effective interest rate to be below zero — about negative 2 percent.
And what should the effective rate have been, based on the economy’s condition? Negative 5 percent, the analysis concluded. In other words, the Fed wasn’t buying enough bonds.
All the while, global investors have continued to show no signs of panicking. If anything, as the economy weakened over the summer, investors became more willing to lend money to the United States, viewing its economy as a safer bet than most others.
After the Fed’s announcement on Wednesday, many of the hawks who warned about inflation earlier this year repeated those warnings anewThe Cato Institute, citing a former vice president of the Dallas Fed, said the new program would “sink” the economy. Mr. Hoenig provided the lone vote inside the Fed against the bond purchases.
It’s always possible that the critics are correct and that, this time, inflation really is just around the corner. But there is still no good evidence of it. The better question may be whether the Fed is still behind the curve.
Some economists are optimistic that it has finally found the right balance. Manoj Pradhan, a global economist at Morgan Stanley, pointed out that bond purchase programs lifted growth in Europe and the United States last year — and a broadly similar approach also helped end the Great Depression. “There are no guarantees,” Mr. Pradhan said, “but the historical precedents certainly suggest it will work.”
Others, though, wonder if the program is both too late and too little. “I’m a little disappointed,” said Joseph Gagnon, a former Fed economist who has strongly argued for more action. The announced pace of bond purchases appears somewhat slower than Fed officials had recently been signaling, Mr. Gagnon added, which may explain why interest rates on 30-year bonds actually rose after the Fed announcement.
One thing seems undeniable: the Fed’s task is harder than it would have been six months ago. Businesses and consumers may now wonder if any new signs of recovery are another false dawn. And although Mr. Bernanke quietly credits the stimulus program last year with being a big help, more stimulus spending seems very unlikely now.
Unfortunately, in monetary policy, as in many other things, there are no do-overs.


http://www.nytimes.com/2010/11/04/business/04leonhardt.html?src=me&ref=business