Forget China, the US Federal Reserve is the world’s biggest currency manipulator
Andy Xie 19 November 2009
As US President Barack Obama glided through China, a chorus erupted in New York and Washington: the problem with the global economy is China’s exchange-rate policy, and Obama’s No 1 job is to slay it. It’s sad that these people actually believe what they are saying: the same “logic” got the world into the current mess. In the feverish hallucination of salvation, they think that moving China’s currency policy would right all wrongs.
The US Federal Reserve is the biggest currency manipulator in the world. Not only does it keep the short-term interest rate at zero through its vast purchase programme for mortgage-backed securities, it also keeps credit spreads and bond yields artificially low. Its manipulation stops money, bond and credit markets from pricing either the Fed’s policy or the US economic plight. All the firepower is packed into the currency market, giving speculators a sure bet on a weaker dollar and everything else rising. Here comes the biggest carry trade ever: the Fed is promising no downside for shorting the dollar.
The US Treasury writes an annual report, judging if other countries are manipulating their exchange rates. It should look in the mirror. Even though the Fed is not directly intervening in the currency market per se, its manipulation is equivalent to pushing down the dollar by non-market means.
The Fed is playing with fire. With such massive speculative outflows, the dollar could collapse, sparking hyperinflation, like in Russia in 1998. The main reason this is not happening is because China’s currency is pegged to the dollar. The speculators believe that there is no downside, only upside from holding yuan. Hence, China’s foreign-exchange reserves are bulging on the inflows. The increases are mostly ploughed back into the US financial market, keeping the dollar up. The dollar’s decline has been “orderly”, falling 40 per cent from the peak without panic selling, because China has been recycling the dollars. The hot money is targeting emerging economies. The last time this happened was between 1990 and 1994 when the Fed kept interest rates low to cope with the Savings and Loans Crisis. The scale is much larger now. The Fed is keeping the funds rate at zero, compared to 3 per cent then, and manipulating the credit cost and yield curve at the same time through its US$1.2 trillion purchases of mortgage-backed securities. The massive hedge fund industry has magnified the transmission mechanism. The huge inflows into emerging economies are inflating dangerous asset bubbles there: we are seeing the strange combination of skyrocketing asset prices and anaemic economic performance. The foundation for another emerging-market crisis has already been laid.
The Fed may think it is fighting a good battle: the overleveraged banks must not collapse, and the millions of unemployed need a growing economy to get their jobs back. But it has the causality wrong. By feeding the unreformed financial system with zero-interest-rate funds, it is feeding a monster with steroids. The asset bubbles in the emerging economies are pumping up their economies in the short term, which supports US exports on the margin. The consequences down the road could be horrific, even for the US. Emerging-market crises have happened in the past when the US economy was strong. The immediate trigger for such a crisis is usually high US interest rates in a strong US economy.
However, inflation, rather than a strong economy, will force the US to increase interest rates. If an emerging-market crisis happens in such an environment, the US economy would suffer from collapsing external demand, with no strong domestic demand at the same time.
Yes, there is an employment crisis in the US. However, monetary stimulus won’t solve the problem. During the globalisation of the past decade, the US economy has lost manufacturing jobs and replaced them with “bubble” jobs in finance, property and retail.
The bubble has popped, and yesterday’s jobs are gone. Tomorrow’s jobs will be created by entrepreneurs who discover new technologies and new sources of demand. This process will take time and no stimulus can be a substitute for it.
During economic restructuring, it is reasonable to keep monetary policy on the loose side. But, how loose? What the Fed is doing is quite crazy. But the policymakers there don’t see the impact in terms of their bubble, even though their policy was mostly to blame for the last crisis. They justify their policies on their immediate benefits. Maybe the Fed thinks that the bubble is on the other side this time and won’t cause much damage at home.
Maybe it thinks that the hot money would force China to appreciate its currency and shrink its manufacturing sector to send jobs back to the US. Such opportunistic thinking is short-sighted and won’t bear fruit.
The Fed should stop its irresponsible actions now and raise interest rates to 3 per cent immediately. There is still time to prevent another global crisis. But I don’t think it will do this. No punishment has been meted out to those responsible for the last crisis. The current policymakers don’t have any incentive to do the right thing for the future. And, because the same people are still in charge, we are destined for another crisis.
2 comments:
Playing with fire
Forget China, the US Federal Reserve is the world’s biggest currency manipulator
Andy Xie
19 November 2009
As US President Barack Obama glided through China, a chorus erupted in New York and Washington: the problem with the global economy is China’s exchange-rate policy, and Obama’s No 1 job is to slay it. It’s sad that these people actually believe what they are saying: the same “logic” got the world into the current mess. In the feverish hallucination of salvation, they think that moving China’s currency policy would right all wrongs.
The US Federal Reserve is the biggest currency manipulator in the world. Not only does it keep the short-term interest rate at zero through its vast purchase programme for mortgage-backed securities, it also keeps credit spreads and bond yields artificially low. Its manipulation stops money, bond and credit markets from pricing either the Fed’s policy or the US economic plight. All the firepower is packed into the currency market, giving speculators a sure bet on a weaker dollar and everything else rising. Here comes the biggest carry trade ever: the Fed is promising no downside for shorting the dollar.
The US Treasury writes an annual report, judging if other countries are manipulating their exchange rates. It should look in the mirror. Even though the Fed is not directly intervening in the currency market per se, its manipulation is equivalent to pushing down the dollar by non-market means.
The Fed is playing with fire. With such massive speculative outflows, the dollar could collapse, sparking hyperinflation, like in Russia in 1998. The main reason this is not happening is because China’s currency is pegged to the dollar. The speculators believe that there is no downside, only upside from holding yuan. Hence, China’s foreign-exchange reserves are bulging on the inflows. The increases are mostly ploughed back into the US financial market, keeping the dollar up. The dollar’s decline has been “orderly”, falling 40 per cent from the peak without panic selling, because China has been recycling the dollars. The hot money is targeting emerging economies. The last time this happened was between 1990 and 1994 when the Fed kept interest rates low to cope with the Savings and Loans Crisis. The scale is much larger now. The Fed is keeping the funds rate at zero, compared to 3 per cent then, and manipulating the credit cost and yield curve at the same time through its US$1.2 trillion purchases of mortgage-backed securities. The massive hedge fund industry has magnified the transmission mechanism. The huge inflows into emerging economies are inflating dangerous asset bubbles there: we are seeing the strange combination of skyrocketing asset prices and anaemic economic performance. The foundation for another emerging-market crisis has already been laid.
The Fed may think it is fighting a good battle: the overleveraged banks must not collapse, and the millions of unemployed need a growing economy to get their jobs back. But it has the causality wrong. By feeding the unreformed financial system with zero-interest-rate funds, it is feeding a monster with steroids. The asset bubbles in the emerging economies are pumping up their economies in the short term, which supports US exports on the margin. The consequences down the road could be horrific, even for the US. Emerging-market crises have happened in the past when the US economy was strong. The immediate trigger for such a crisis is usually high US interest rates in a strong US economy.
However, inflation, rather than a strong economy, will force the US to increase interest rates. If an emerging-market crisis happens in such an environment, the US economy would suffer from collapsing external demand, with no strong domestic demand at the same time.
Yes, there is an employment crisis in the US. However, monetary stimulus won’t solve the problem. During the globalisation of the past decade, the US economy has lost manufacturing jobs and replaced them with “bubble” jobs in finance, property and retail.
The bubble has popped, and yesterday’s jobs are gone. Tomorrow’s jobs will be created by entrepreneurs who discover new technologies and new sources of demand. This process will take time and no stimulus can be a substitute for it.
During economic restructuring, it is reasonable to keep monetary policy on the loose side. But, how loose? What the Fed is doing is quite crazy. But the policymakers there don’t see the impact in terms of their bubble, even though their policy was mostly to blame for the last crisis. They justify their policies on their immediate benefits. Maybe the Fed thinks that the bubble is on the other side this time and won’t cause much damage at home.
Maybe it thinks that the hot money would force China to appreciate its currency and shrink its manufacturing sector to send jobs back to the US. Such opportunistic thinking is short-sighted and won’t bear fruit.
The Fed should stop its irresponsible actions now and raise interest rates to 3 per cent immediately. There is still time to prevent another global crisis. But I don’t think it will do this. No punishment has been meted out to those responsible for the last crisis. The current policymakers don’t have any incentive to do the right thing for the future. And, because the same people are still in charge, we are destined for another crisis.
Andy Xie is an independent economist
Post a Comment