Damn it Yellen – Wake Up
I had an email from a friend who stated ‘Yellen will not increase interest rates’ – to which I agreed -my comments in fact contradict what I have written on this blog in the prior post ‘Game of Clones’.
Why did I agree with him?
The U.S. Federal Reserve can increase interest rates – but they are idiots – they will not – and those reasons are the external impact of a strengthening U.S. dollar on highly indebted countries.
Yes external – global financial system stability – and in that vein stuff the national monetary policy – Pension funds – and savers as the highly indebted global countries have priority – push the U.S. Pension funds and those that do save monies – into risky assets – create a stock market and housing bubble and in so doing – ruin the middle class and support Main Street bankers.
What Yellen and the other Governors of the Federal Reserve do not realize is that they can increase interest rates – and to offset the strengthening of U.S. dollar – place a limit on the amount of U.S. dollars that can be held external to the United States.
In other words limit the amount of U.S dollars that can be invested in – by ALL countries – central banks and for international trade.
Currently around 62 percent of all foreign holders are invested in the U.S. dollar and that means in macroeconomic terms – that there is a distortion – whereby this foreign investment does nothing for the advanced U.S. economy – in actuality it reduces the savings by the U.S. consumers – they become net spenders.
Investments in the U.S. dollar reserves should be capped – reduce the exposure by at least 20 percent – force foreign central banks to take on other currencies – from advanced economies.
Reduce this distortion – limit the amount of foreign investment in the U.S. dollar and this will basically force everyone – to seek solace in another currency – the first cab off the rank would be the Euro – that then would allow the E.U. to deal with their own domestic problems – as too Yen and the Japanese economy – GBP and England.
The U.S. would benefit principally through the consumers savings rate – this would increase – debt reduced.
The stupidity of the current situation being allowed to continue – forces an increase in the value of the U.S. dollar against all currencies – and that in itself perpetuates the currency wars – those engaged in this war of depreciation of currency value – just pass the deflation onto their major trading partners – and the pain of indebted emerging economies will only get worse – as the global trade continues its downturn.
That process in global trade cannot be halted under the current circumstances – each country has to address their own domestic issues – politicians – add consumers to that basket as well – have to wake up and stop spending and reduce the size of government – debt – and operate within a ‘surplus’ current account budget.
And yes – governments operating on a current account surplus is totally at odds with the majority of economists including one Krugman – if someone could show me the benefits of increased spending and debt – that goes against a ‘trend’ of global declining trade and a deflationary spiral – then that essay I would be interested in reading.
The U.S. dollar is the global reserve currency – currency of choice with ‘dark matter’ attached – an insurance policy if you wish – that the U.S. dollar will be accepted in every currency.
The majority of international transactions are conducted in U.S. dollars for that simple reason – that – together with the world’s largest economy and the ability to issue U.S. dollar credit at will.
The U.S. Government and the U.S. dollar are ‘the hegemon’.
And no – the U.S. dollar will not be replaced by any other currency as the ‘global reserve currency’ – unless of course the U.S. deems this necessary – highly unlikely as there is no equal – no peer – and whilst the U.S. dollar retains this status – there is demand – and this enables the U.S. Treasury to borrow – at far lower rates than other countries.
The latter would not be the case should that dollar not hold that ‘global reserve status’ and hence the U.S. Treasury would never support this contention – especially in light of the U.S. debt situation – the budget would be blown just on the interest payments alone.
This current inflow of foreign capital into investments in the United States – grossly distorts the U.S. economy – whereby the net results of the trade deficits – is that the consumers do not save. If one wants confirmation of this fact – they should check Stephen Roach’s copious articles on this very subject.
If the U.S. dollar wants to retain credibility in the market place – then the U.S. Federal Reserve should act accordingly – instead they are acting like pre-schoolers – playing with the ‘value’ to deter interest increases – to reduce the strength of the dollar – and in so doing making the currency wars far worse.
For every action – there is an equal reaction – a balancing must take place and ignorance of capital flows is no excuse for the powers of the Federal Reserve – nor for that matter the U.S. Treasury.
Yes – the U.S. Federal Reserve and the U.S. dollar will lose credibility by virtue of nothing being done to normalize interest rates – the currency itself and the U.S. Federal Reserves comments – whether dovish or hawkish on the U.S. economy – and world economy will have no bearing whatsoever on the value of the U.S. dollar against all currencies.
The policy of ‘do not fight the Fed’ will become meaningless – whilst the stupidity of those that have control of the interest rates previously – Messrs Summers, Volker, Greenspan and Bernanke dictating higher and lower rates – all that transpired was the creation of speculative bubbles – that popped with significant impact on the U.S. and other country’s economies.
The U.S. Federal Reserve in attempting to stop a strengthening dollar – will not deter capital from seeking U.S. dollars – this in turn will increase the value and have an adverse affect on those countries that borrowed in the U.S. denominated debt – a lot – it is cheap money in the scale of things – a bubble in sovereign debt.
It is a fact – that any country whose economy is ‘perceived’ as a safe haven – in times of trouble – whether – increased political and economic instability – war – will receive huge inflows of capital creating currency disruptions.
Take the U.S. dollar during the Bush era and the invasion of Iraq for the non existing ‘weapons of mass destruction’ – the initial rally in the U.S. dollar left everyone gasping for breath – short lived as it was – it was a flight to a ‘safe haven’.
What made the matter worse was the ‘short covering’ by hedge funds and institutions – the buying of U.S. dollars to limit losses.
More recently the exit of capital from the Euro – through individual country insolvencies – Club Med countries – and the transfer of capital to those periphery safe haven countries – in particular Switzerland – Sweden and Denmark.
The flow on effect is the imposition of negative interest rates to defer currency speculators.
Then we have current situation with the British pound – and the Euro – being sold all due to the ‘Brexit’ vote – the uncertainty with the E.U. alliance – through propaganda of the ‘stay’ group and apparently 72 percent of economists – if they are economists that is – causing intense mischief with capital fleeing from the pound to the Yen and U.S. dollar – Australia and Canada.
I commented in a recent blog ‘Yen – Currency of Choice’ due to the flip-flopping of the U.S. Federal Reserve on interest rates.
Capital sought Yen over the U.S. dollar as Japan was perceived to be the most stable currency – only due to the Bank of Japan investing very heavily in U.S. Bonds – nearly on par with China.
If you have been reading these recent blog entries – and on the subsequent strengthening of the Yen – I put this firmly at the feet – or mouth – of one Janet Yellen – the U.S. Federal Reserve chair – and rightly so.
As a lot was at stake for the Japanese economy and the major trading partners – a subsequent monetary policy was introduced – that transferred deflation to the major trading partners Australia – New Zealand – both of these countries had to deflate their currencies through reduction of interest rates – and thereafter China devalued – and they will continue to do so ‘ad nausium’.
China has no choice – if they freely floated the Yuan – it would sink – against all currencies – thereby creating a devaluation of all assets domestically – exports would be very costly and their manufacturing competitiveness would collapse.
The process that they have chosen was to de-peg the Yuan against the U.S. dollar and peg the currency to a basket of currencies – one presumes their major trading partners.
If Yellen does increase the interest rates – which she should do – as the U.S. economic ‘window’ is still ajar to accommodate further rate increases – then the opportunity is available to discourage investment in the U.S. – limit central bank investments.
The stage will be set to allow a gradual normalization of interest rates globally – with heartache for those countries that gorged themselves on U.S. dollar loans.
From my perspective the indebted countries – deserve everything that comes there way – greed of the politicians – self serving largesse in spending to be reelected – with little forethought – as to the fact that the current low interest rates will not – and cannot stimulate an economy.
Consumer spending – through further borrowings – has its limits.
Austerity will be demanded from the citizens – this will be a further burden due to the lunatic politicians being in control of the public purse – yes the simple fact of the matter is that taxpayers will have to repay the debt – regardless of which government is in control of any country.
Should Yellen not increase rates – then she won’t be able to do so in the future – the economic window – to correct the past wrongs is closing – the Japanese disease of deflation and higher unemployment – together with higher debt levels – will continue for the foreseeable future.
The recent mellow U.S. employment numbers are a testament to this.
Just look at history – the Japanese economy has had the ‘low interest regime’ and high debts to GDP for 25 years and nothing – repeat nothing – that the Bank of Japan has tried has worked.
We are living in extraordinary times – in normal circumstances the non increase in rates would eventually lead to the normal spate of higher inflation rates – increased costs.
With rising inflation – increased demand for relatively cheaper imports – and a reduction in exports further deteriorates the current account deficit – leading to a dollar depreciation.
This is not the case this time round – deflation is rampant around the globe and all country current accounts are in deficit – or close to deficit signaling no growth – thereby deferring any normalization – demanding Keynesian stimulus to kick start individual economies.
And where do they get the money for that?