Tuesday, November 27, 2007

Ministers of Silly Walks

Put yourself at Bernanke's shoes; better yet, get Paulson's shoes too and combine them: wear Ben's shoe on the left and Hank's on the right. The goal is to try and walk a straight and narrow a line for the economy, without embarrassing yourself. I submit that this is, in fact, impossible.

On the one foot, the Fed is getting screamed at to lower interest rates by at least another 200-250 basis points: PIMCO, Greenspan, The Conference Board, every bank and broker in town and abroad - they all demand and expect cheaper money for a variety of reasons, all immediately and extremely mercenary. The bond fund managers are salivating at the potential of capital gains from short and medium treasurys, the banks and brokers need the massive cash bailout to stanch the bloodletting from their toxic paper and real estate portfolios, the businessmen need the consumer to keep spending and Greenspan wishes above all to remain relevant - even in retirement.

On the other foot, the Treasury is finally getting pressured about the plunging value of the dollar. Until recently, such strain was easily kicked aside: cheap imports from China and its pegged yuan easily balanced imported inflation, the moribund Japanese economy kept the yen low and rising oil prices and export volumes kept the sheikdoms mostly happy, even if their currencies were pegged to the dollar. The Russians, also highly dependent on dollar-denominated oil and gas exports, were a concern but not nearly as important as 20 years ago. The European manufacturers were taking it on the chin, but no one really cared about them except european politicos - another cast of nobodies, in the US's eyes. But all of these factors are now reversing with a vengeance.

China is finally experiencing domestic consumer inflation as well as a runaway bubble in financial and capital assets. Japan needs to raise the value of its currency to ease the burden of imported oil and gas as the yen gets an additional boost from the unwinding of various carry trades. The oil sheiks are getting worried: not only are a lot of their expenses in euros, $100 oil is finally weakening the global economy and threatening to kill their golden goose. There is a constant murmur about "re-valuing" their currencies, "re-balancing" their financial reserves, etc. Russia is flexing its geopolitical muscles, fed on a rich diet of energy exports. And last, if always least, the Europeans are getting really ticked off at America's cheap dollar: Airbus, that most emblematic of their industrial global champions, is in a mortal battle for its survival.

Each one of these developments could easily be dismissed, if they occurred in isolation. But all of them together point to a threat so critical to America's interests that they can no longer be ignored: what is at stake here is the role of the dollar as undisputed global reserve currency. I won't explain why this is of vital importance to the United States - I trust readers understand. So, the pressure to restore the value of the dollar must be getting strong within the Treasury Department and the Washington establishment.

The Bernanke - Paulson team is thus experiencing a severe conflict. To take the "shoe" analogy one step further, one bunch of salesmen wants the US economy to wear a size 14 monetary and fiscal policy on its left foot, while another bunch wants to squeeze a size 6 on the right. Given that Ben and Hank do not wish to join Monty Python's Ministry of Silly Walks, they must soon reach a decision about their shoes and stop playing footsie with the economy.


  1. Substantial erosion of the dollar's status as THE reserve currency is a bigger threat to the US than even a severe recession.

    Those betting on huge additional rate cuts may be making a big mistake.

  2. To the best of my understanding the last comparable event (removing whatever 'solid' mooring was under the world financial system) is when the UK went off the gold standard, and allowed the pound sterling to float.

    This was in 1931 and it's my impression that most people have little awareness of how this contributed to the Great Depression (enormously). Smoot-Hawley and international trade - maybe yes. The collapse of the gold standard - no (although it didn't occur as a single event).

    And these (new views on what contributed to the Great Depression) have been precisely Bernanke's area of research prior to taking over at the Fed.

    The change doesn't _have_ to be this painful. But changing the underpinnings of the world financial system is a very fraught undertaking.

    What are the alternatives? The Euro looks good at the moment but what are Europe's long-term economic prospects?

    And Japan and China. Aside from heft or skill, neither yet wants to take on the responsibility.

    They'd much rather continue as free-riders on the world economic system until (or if-and-when) they own it.

  3. now is the time to break the Asian dollar peg ... under cover of the current financial 'crisis'.

    it's absolute nonsense to think that we can let this currency manipulation by Japan, China, Korea, etc. continue unchecked.

    we have the perfect cover to continue to lower rates. and hey, they can always 'decouple'.

    we are in a much better position to weather the subsequent storms than our competitors. and yes, they are our direct competitors in a zero sum game.

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