Kasriel - "Greenspan in Checkmate" ?
( I think we said this was coming...)
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United States Daily Economic Commentary
The Dollar Is Down, Gold Is Up - Checkmate for Greenspan?
August 09, 2001
Excess money growth in 1997 and 1998 is what enabled a bubble to develop in IT investment and the NASDAQ. The Fed is trying to cure our post-bubble economic hangover by the "hair of the dog" - excess money growth. Today, the ECB issued a report saying that Euroland first-half growth was quite weak and that there were "sizable" downside risks to second-half growth. The implication of this is that the ECB is getting ready to crank up its printing press, too. As the chart below shows, both the Fed and the ECB already have their money printing presses running at high speed. All else the same, additional cuts in their policy interest rates will cause the printing presses to run that much faster. And although the BOJ comes in a distant third in the money-printing competition, the second chart below shows that it is starting to make a move.
CPI-inflation adjusted overnight rates in the Big-3, the US, Euroland and Japan, have been moving lower. Currently these rates are 0.50% for the US and Japan, and 1.40% for Euroland. With both the Fed and the ECB ready to cut their respective policy interest rates and with the BOJ being urged from both within and without Japan to print enough money to arrest deflation, it will become more difficult for global investors to earn a positive inflation-adjusted return on their overnight investments. This is why the price of gold rallied above $276 an ounce at one point in today's US trading session. Back in early April, the price of an ounce of gold was languishing at $256. If all of the central banks of the Big-3 are preparing to debase their currencies more, why is the dollar depreciating against the other two? Because the dollar has served as the world's reserve currency. Global investors "park" their excess cash in the US until they decide how to deploy it. With the Fed signaling that it is no longer prepared to guarantee global investors a positive return over inflation on their "parked" funds, folks are starting to look for another place for their funds to hang out. Some investors may therefore be moving their funds to Euroland and Japan.
If, in fact, the dollar has entered a downward trend, this could be checkmate for Alan Greenspan. It would be very difficult for him to keep cutting the funds rate after August 21 in the face of a declining dollar. Why? Because a falling dollar would raise inflation expectations. Maybe he wouldn't need to cut rates anymore because a falling dollar would boost US exports? That's right. In addition, US money supply growth would likely grow even faster. Why? Because as global investors pulled their funds out of the US, their would be an excess demand for credit. Unless the Fed was willing to let the funds rate move up, it would end up creating the credit to accommodate the excess demand. That would stoke US domestic demand along with the higher foreign demand. US inflation has been rising as the economy has stalled. Do you think it would move lower if the US import prices fell at a slower rate and US domestic demand picked up? No. So, Greenspan would have to put his policy where his mouth has been with regard to containing inflation. If he didn't, the bond market would revolt. Money supply growth would grow even faster, adding more fuel to the inflation fire. If Greenspan did raise rates and cut back on the printing of money, this still highly-leveraged economy might crack under the debt service burdens. Take it from me - a weaker dollar is the last thing the US should want right now.
Paul L. Kasriel
Director of Economic Research |
