Don't blame Fed for weak dollar
Commentary: Interest-rate cuts did not cause dollar's decline
By Lou Barnes, Monday, May 5, 2008.Long-term interest rates stayed about the same (mortgages 6 percent, 10-year Treasury 3.84 percent) as markets quarreled over the meaning of a new mountain of data.
The Labor Department said Friday that the unemployment rate in April declined to 5 percent, and payrolls lost only 20,000 jobs. For all the attention paid to this report each month, it often wildly mis-describes the economy; this one was so weird that not even economic optimists are crowing. In authentic news, claims for unemployment insurance jumped 35,000 to a cycle-high 380,000, total on benefits to a five-year, 3-million high.
The Fed's post-meeting statement laid it out: "Economic activity remains weak." Those who expected the Fed to identify a cycle-end, a rebound in sight, were mistaken. First-quarter '08 GDP arrived at a 0.6 percent gain, but adjusted for inventories contracted about 1 percent. The GDP measure of inflation was excellent, surprisingly stable.
Factory orders had a good month, plus 1.2 percent, driven by overseas demand. That foreign-market support for big business explains the sensation of two economies, big healthy, consumer not.
As the economy stumbles, the failure of political leadership has been matched by shortcomings in the professional financial class. Specifically, in the 45 days since the Bear Stearns liquidation the Fed has received extraordinarily unfair and unfounded criticism, the worst from people who should know better.
The Fed has been the only public agency to respond adequately to this crisis, yet talking-heads every hour rip it for its Bear action, its wider effort to provide liquidity and credit to the system, its inattention to inflation, and its rate cuts.
Above all other things the Fed is raked for its failure to "defend the dollar." It is true that in the near term international money runs uphill to high interest rates, especially if paid by low-inflation nations. The European Central Bank has held the eurozone cost of money at 4 percent versus the Fed's 2 percent, and a 10-year German Bund trades 4.12 percent versus our 3.85 percent -- no wonder the euro has become a collector's item.
The Fed's critics insist that its rate cuts are the cause of dollar decline. This argument is an ancient, gold-standard relic. If your nation ran a big trade deficit, and your currency weakened, and you began to hemorrhage gold, the only cure was to jack your rates to slow your economy so that your people could not afford to buy imports. In the modern, post-gold world (since 1972), trade deficits have tended to self-correct: The currency of the excessive importer lost purchasing power, and imports fell.
The rate-critics fail in endgame. Let's suppose the Fed had raised its rate this week a percent or two. The dollar would have rocketed. Defended! For a while, until an already caving economy caved altogether, at which point the Fed would have to cut rates deeper than in the first place, triggering a dollar dive worse than the original. When we hit economic bottom and begin recovery, the dollar will find better ground.
Trade flows are the real cause of structural dollar trouble, and our trade deficit in turn has two sources not imagined in classical economics: "managed trade" and oil.
The historical method to engineer a trade surplus (and allegedly to protect domestic industries) has been to tax imports by tariff. The Japanese invention after WWII was the "non-tariff" trade barrier: while pretending to embrace free trade, it was un-Japanese to buy foreign products. Likewise un-Malaysian, un-Korean, un-Taiwanese, un-Chinese -- all very much unlike the balanced trade conducted by Europe and Latin America. Our Pacific Tiger "partners" resist our exports by willful avoidance having nothing to do with currency or price advantage, running constant surpluses with us in the range of 7 percent of their GDPs. Oblivious, we pursue free trade, and are fleeced.
The second source of dollar trouble, oil ... I do not know of a nation ever more dependent on importing a single commodity than we are (Rome and grain?). Do the math: 13.5 million barrels per day at $100/bbl = $492 billion this year.
And the foolish critics want to blame the Fed for a weak dollar?
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
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Submitted by Nancy Judovits on May 5, 2008 - 5:36am.
Finally some common sense! The trade imbalance and high oil prices cannot help but errode the value of the dollar. I am glad to see someone calling it as I see it, too.
Nancy Judovits
NancyJRealtor.com
Submitted by Kenneth Belferman on May 5, 2008 - 7:01am.
It's amazing to me how persistent the disinformation campaign is to exonerate the Fed and its monetary policies. The defintion of inflation is quite simple - it's an increase in the supply of money. Period. Real common sense will tell you that when you increase the supply of any commodity, its value drops. Since the dollar is not backed by anything of value (like gold or silver) it's easy to create money out of thin air - which is what the Fed does. So, when the monetary supply increases, the value of the dollar drops and prices rise. Economics 101. This is why the dollar has lost more than 70% of its value over the last 70 years.
Submitted by Sean OToole on May 5, 2008 - 8:22am.
Lou is one of my favorite commentators here- but I'm with Kenneth on this one. While our dependence on oil clearly needs to change, its time we took some ownership for our economic blunders rather than blaming red herrings like free trade. While the recent Bear Sterns bailout was likely necessary to avoid a financial meltdown, lets not forget that it was the fed that allowed, even encouraged, derivatives to develop into financial weapons of mass destruction in the first place.
US taxpayers need to know that they are already footing the bill for this bailout in the form of higher oil and commodity prices. To save our banking institutions from their greed and stupidity the fed is creating new money at unprecedented rates - it is unreasonable to think that has no impact on prices.
Submitted by Jorge Zarate on May 5, 2008 - 8:46am.
I just hope people take the time to read Kenneth's and Sean's comments (maybe this one). Most people don't read and don't understand economics. The few who start to read don't know about critical reading and believe anything they read.
I am making a lot of money out of this situation and I can feel the rise in my cost of living. In other words, what good is it going to do me to make more money if it's worth less. I'm essentially becoming a poor millionaire.
People are not going into foreclosure just because they are in adjustable rate mortgages. It is the average american who lives day to day on a tight bugdet that's being greatly affected by our economic situation. It is them who have worked hard to get a house and pursue the american dream who are affected the most. Those who came with stated income subprime loans, whom we all know shouldn't have, were screwed to begin with.
Needless to say, I will blame the Fed even though it's making me money....
Submitted by Dan Homan on May 5, 2008 - 9:34am.
It is so good to hear a voice of reason in this whole matter. Everyone knows that the federally backed and insured private banking cartel is not to blame for the dollar's demise at all. Instead it is the highly regulated and taxed nasty oil companies, and the imbalance of trade. Oh my God, it is about someone with half a brain like yourself stood up for big banking, after all they will need alot of support when the time comes for the FDIC bail outs at taxpayer expense because of all those stupid people who did not read their morgage papers before closing, and stuck those poor banks with bad loans that even their highly trained underwriting departments with their golden standards for lending other peoples money could not detect was a problem until it was too late.
This lower rate is so that they can loan cash to other banks who are short on their fractional reserves and need some cash to make it up. It is a shame that this cartel loans money to its mambers at 2% for short term loans, but charges the US Government about 8% for short term bonds.
You are right the banks are not the problem, they are the soloution. Let's give them a pass, and put the blameon the free market where it belongs.
Submitted by Abe Ulug on May 5, 2008 - 12:29pm.
I read the title of Lou's article first. I read the comments next. I finally read the article in its entirety.
I don't think Lou is wrong in anything he says or any of his conclusions, nor is Kenneth, Sean or Jorge in my opinion.
Deciding who is right and who is not is like deciding which came first, the chicken or the egg.
All these factors feed one another in a vicious circle and have been for at least 30+ years. At the end of the day, trade deficit, lack of savings (thus import of capital), swelling money supply and national debt all feed one another. The Fed does not print money because it wants to, it does because it has to as last resort. Oil companies import oil because there is demand at the gas pump. Banks loan money competitively as long as the supply has not dried.
In my opinion, the problem rests with the Federal Govt' who has the responsibility and authority to maintain a stable, growing economy. The problems we face today were predictable and avoidable but Washington has not acted when it needed to.
Lou once referred to the Fed (Federal Reserve) as a figure skater. The Fed has been skating around the Government's actions (or lack there of) and may not be as graceful as one would like to see but should not be blamed for the current state of affairs, specifically the devaluation of the dollar. The policies which led to the unsustainable deficits and credit supply should be.