A warning shot
You may have heard recent controversy over the U.S. Federal Reserve Board buying Treasury bonds--$600 billion in all--and wondered what all the fuss was about. You may even have wondered why one branch of the government is buying bonds from another one.
The headlines say that this is a "stimulus" measure, which basically puts more money into the U.S. economy without costing the taxpayers anything. This is true, up to a point; buying Treasury securities means the central bank is essentially creating new money. Other analysts say that creating new money is inflationary, which also tends to be true. However, the Stratfor Global Intelligence service has pointed out that creating $600 billion over eight months is not dramatically more than the Fed's normal actions in managing the money supply, and with $8 trillion in circulation (the M2 money supply figure, which does not include CDs and institutional money market fund balances), dollars are not going to suddenly become dramatically more plentiful. And in a $14.3 trillion economy, the stimulus is not likely to turbo-charge the next round of employment figures. It probably won't even show up in GDP.
So what gives? Looking at the global economic picture, right before the G20 economic summit, Stratfor notes that export nations like Japan and Germany have linked their recovery hopes to selling more to U.S. consumers. The more they sell, the more they drive up the difference between U.S. imports and exports--or, in economic terms, widening the current account deficit and diverting money from our economy into theirs. To do this most effectively, they need their currency to be weaker than the dollar so that their manufactured items look like a bargain. Stratfor notes that Japan has been openly intervening in currency markets to drive down the yen. Germany, meanwhile, doesn't have to: it has benefited from a weakened euro--the result of well-publicized debt problems in Greece, Spain, Portugal and most recently Ireland. An article in the November 5 issue of the Wall Street Journal says that not only Japan, but also Brazil and South Korea have taken actions to depress their currencies against the dollar.
Seen in this light, the Fed's action can be seen as a warning to the other nations that the U.S. is capable of protecting its currency and export industries from these raids on its economy. The $600 billion purchase probably won't affect the value of the dollar, but they show that the Fed is well aware of the actions of the other countries. As U.S. representatives negotiate to stop currency manipulation at the G20 summit, the rest of the world knows that if there is no agreement, the U.S. is capable of fighting back. Sure enough, The Wall Street Journal quoted finance ministers and economists from Brazil, France, South Korea and Germany, all criticizing the purchase and calling for a cease fire in the currency wars.
Should we worry about inflation as these negotiations drag on? At a time when the worst-case economic scenario is deflation, a few small nudges in the inflation rate might not be the worst thing to befall the U.S. economy; today's rate is well below the 2% target informally set by the Fed. Should we worry about a falling dollar? If you're traveling abroad, or buying a foreign car, then you might have to pay a bit more if the dollar weakens against the currency of the nation you're traveling to or where the car was made. But foreign stocks, bonds and mutual funds are always a little more valuable--in dollar terms--whenever the dollar declines in value, so your international holdings could get a small boost in return.
But the most likely scenario is that the Fed's demonstration will keep everybody at the negotiating table. And you'll continue to hear the conventional interpretation: that this is all about stimulus back home--which, to the extent that it keeps other countries from raiding our economy, it is.
Sources:
Stratfor analysis: http://www.stratfor.com/memberships/175231/geopolitical_diary/20101103_washingtons_warning_shot_currency_front
U.S. money supply: http://en.wikipedia.org/wiki/Money_supply
Size of the U.S. economy: http://en.wikipedia.org/wiki/Economy_of_the_United_States
Wall Street Journal articles about the Fed's repurchase: http://online.wsj.com/article/SB10001424052748704353504575596203544367856.html
and: http://online.wsj.com/article/SB10001424052748704327704575614853274246916.html?mod=WSJ_article_MoreIn_Economy
