PrintOctober 19, 2010
The Schizophrenia That Is U.S. Economic Policy
The United States, the largest economy in the world, is presently pursuing monetary policies that threaten the stability of the global economy. It is yet another foolish attempt to jump-start the domestic economy while ignoring the other half of the equation so necessary to achieve a sustainable economic recovery.
This is reflected in worldwide concerns about currency exchange rates, as the U.S. trade and budget deficits continue to skyrocket. The Federal Reserve, in a last-ditch effort to spur a modicum of inflation and increase demand for borrowing, has announced that it is mulling over another round of quantitative easing.
(This is a euphemism for, in essence, printing money, as the Federal Reserve increases the money supply by buying government bonds from the market, thereby flooding the financial institutions with capital in an effort to promote increased lending. This is used when central banks have already reduced interest rates to nearly 0% and have failed to produce the desired effect. The major risk is that with so much money floating around and with a fixed amount of goods available, this action will eventually lead to higher prices and runaway inflation.)
At the same time, and almost guaranteeing that this easing will not succeed, there is no inclination on the part of the Obama administration to put a brake on spending, tax increases or new mandates and regulations, thus suffocating the private sector so it cannot create jobs and wealth so necessary to increase demand for goods and services. Domestic and foreign consumption of goods and services produced in the United States is vital to reduce deficits and reset the U.S. economy.
The global reaction to the policies of the Federal Reserve and the Obama administration is reflected in the main source of worldwide contention: currencies, particularly the value of China's renminbi. China's policy of not allowing its currency to float creates a distortion and should be stopped, but that is not the major issue in today's global economic imbalance. That imbalance is the result of a lack of coordination in macroeconomic policies among the major economies, particularly the United States, which appears ready to embark on a path that may cause further worldwide financial distress.
With the United States unable to rely on foreign or even domestic demand for its products and Fed Chairman Ben Bernanke publicly flirting with an explicit inflation target, further monetary easing seems likely. This prospect has sent the dollar plummeting against most major currencies. There will be a further fall if the Fed moves forward with this proposal, thus accelerating the flight from the dollar.
The question is how effective this leasing would be. Long-term interest rates in the United States are already extremely low. Currently, U.S. assets offer very low returns to investors, and the financial system remains in weak health. There will be little or no additional benefit to the U.S. economy (except to make the possibility of hyper-inflation in the United States sometime in the future a more real possibility.) At present, much of this new money will find its way into higher-yield emerging markets such as Brazil, Malaysia, and Thailand.
This potential flood of liquidity could create a huge asset bubble in these emerging markets. Already many of these countries have seen their currencies increase dramatically against the dollar, and the flow of investment capital has begun prompting many of these nations to institute various capital controls. But these controls are easily circumvented, and many of these countries could be overwhelmed by large inflows.
The bad news -- not only for these emerging markets but for the rest of the world -- is that the next major threat to the global economy could originate in these countries.
The reason the Federal Reserve is even contemplating further easing and is willing to roll the dice with the global and domestic economy is the ongoing lack of U.S. economic growth and the continual government deficits for as far as the eye can see. Unless and until there is a significant growth in the economy and government spending is severely curtailed, the Federal Reserve will be called upon. It is apparently willing to continue printing money by buying government debt and making money cheap in the myopic hope that such action will jump-start the economy.
However, the private sector will not borrow or expand and create jobs as long as there is a government in Washington, D.C. hell-bent on strangling this sector with taxes, regulations, and mandates to fulfill its dream of income redistribution. This is an environment that makes it impossible to operate and plan for the future.
The policymakers at the Federal Reserve know that only a vibrant private sector can create economic growth in such a huge economy. Yet they are unwilling to make clear to this administration and Congress that the problem with the national economy rests at their doorstep. Instead, in what can be described only as an incestuous relationship, the Federal Reserve and the administration appear willing to steer the ship of state toward an iceberg and hope that at the last moment they can successfully avoid it.
It is a fool's errand for the Federal Reserve to think that by monetary policy alone it can resurrect the U.S. economy. It is not the mandate of the Federal Reserve to do what the government policymakers refuse to do -- namely, be responsible for sustaining economic growth by sensible budget and regulatory policies.
The world economic outlook remains precarious. Olivier Blanchard of the International Monetary Fund commenting on a sustained world recovery said,
It requires two fundamental and difficult economic rebalancing acts. The first is internal rebalancing-a return to reliance on private demand in advanced countries and retrenchment of fiscal deficits...The second is external rebalancing-greater reliance on net exports by the U.S. and some other advanced countries and on domestic demand by some emerging countries, notably China.
Unfortunately, a Federal Reserve that crosses it fingers as it throws darts at the wall in the hope of finding something that works and an administration wedded to fiscal policies the polar opposite of what is necessary for a sustained recovery could well bring the global economy to its knees and usher in a sustained period of economic stagnation. The Federal Reserve may have outlived its usefulness if it does not aggressively confront the administration and Congress over their fiscal and regulatory policies while curtailing its own foolhardy actions.
