It’s never a good thing when another country calls your financial policy clueless. It’s particularly bad if that other country is one of the world’s leading economies, and if it also happens to be right.
"With all due respect, U.S. policy is clueless," German Finance Minister Wolfgang Schaeuble said recently, referring to the Federal Reserve’s decision to throw $600 billion at our sluggish economy.
The Fed can create as much money as it likes, but the U.S. economy is presently unable to productively put that money to work. By setting near-zero interest rates, the Fed has established that money in this country has no real value. We give it to the banks for nothing, and the banks lend it back to the deficit-ridden U.S. Treasury for almost nothing. The result is a guaranteed profit for the banks, but no incentive to lend cash to creative entrepreneurs or expanding businesses.
The Fed’s $600 billion intervention will make this foolishness more efficient by cutting out the middleman. There will be no need for banks to buy Treasury securities for the next eight months. The Fed plans to buy, for itself, just about as much debt as the Treasury plans to sell in that period. The banks will just sit there uselessly, unable to attract deposits with near-zero rates (or negative rates for many depositors, when fees are considered), and unwilling to risk making loans to businesses in a weak economy while regulators are worried about the banks’ financial strength.
The whole idea behind banking is to have solid, well-capitalized institutions that can attract deposits with a fair rate of interest, and still make a profit by lending depositors’ money at higher, yet reasonable, rates to creditworthy borrowers. It’s a great system. We ought to try it.
Instead, we are going to flood developing nations, which offer better potential investment returns, with cheap dollars. South African finance minister Pravin Gordhan warned that “Developing countries, including South Africa, would bear the brunt of the U.S. decision to open its flood gates without due consideration of the consequences for other nations.” Those consequences will include asset bubbles, inflation and painful currency gyrations.
Brazil's Central Bank Governor, Henrique Meirelles, told reporters that already “excess liquidity in the U.S. is creating problems in other countries.” Brazil’s currency, the real, has risen 39 percent against the dollar since the start of 2009, interfering with the country’s export market.
The Group of 20 summit in South Korea this week gave President Obama an opportunity to defend U.S. policy, but it’s not an easy policy to defend. The only truly convincing argument he could offer is that in 2012 this country might elect more responsible officials and get itself back on track. Not surprisingly, that was not the message the president wanted to deliver. Instead, he planned to focus on drumming up support for another bad policy move: capping current account surpluses and deficits at 4 percent of gross domestic product.
This proposal, first floated last month by Treasury Secretary Timothy Geithner, has allowed the Chinese to cast themselves as wise and responsible players while blatantly manipulating their currency in order to keep it pegged to the U.S. dollar. Chinese Vice-Foreign Minister Cui Tiankai said in a news briefing, “Of course, we hope to see more balanced current accounts. But we believe it would not be a good approach to single out this issue and focus all attention on it. The artificial setting of a numerical target cannot but remind us of the days of planned economies.”
The proposal to cap account imbalances simply highlights the fact that the United States has failed to bring what it buys from abroad into any sort of reasonable relationship to what it is able to sell overseas. Rather than actually working to accomplish this balance through domestic policy, we want to impose on the rest of the world the financial discipline we lack.
The United States is the lynchpin of the global economy. We buy more stuff than anyone else, we make more stuff than anyone else, and we produce the currency that everyone else uses as either a direct or indirect reference point. If the United States fails to adopt responsible financial policies, the rest of the world will have to sever ties or risk being pulled down as the American economy sinks.
The world is losing confidence in our financial common sense. Just this week, China’s Dagong credit rating agency reduced its rating on U.S. government debt from AA to A+. If Obama cannot address this country’s problems at forums like the G-20 summit, foreigners will have little choice but to do what they can to mitigate the effects that our mismanagement could have on their countries.
The first thing other countries will need to do to insulate themselves from failing U.S. economic policy is to stop lending money to a country that thinks it can whip up prosperity by creating gobs of cash out of thin air. As our bonds mature, we will be unable to refinance them by issuing new paper to foreign buyers.
The Federal Reserve has sworn not to "monetize" the debt by buying bonds the Treasury cannot sell elsewhere, but it will end up having to do exactly that to avoid default. The dollar will plunge. Commodity prices and U.S. inflation will very likely soar. Other countries will begin to demand that we pay for their products using currencies that still have value. We’ll still be able to get Middle Eastern oil and Italian leather shoes, but only when we can scrape together the euros, yuan or Swiss francs that the market will demand as payment.
The eventual result will be a recession far worse than the one we just experienced. And, in this future downturn, the government will not be able to borrow money to provide extended unemployment benefits or other relief programs.
Schaeuble was exactly right when he called American financial policy “clueless.” The fact that the rest of the world is beginning to see this is, in fact, a clue to what is ahead for America. Here’s another clue: It isn't going to be pretty.
November 15, 2010 - 11:51 am
Precisely my view and perfectly expressed. Thank you.