Smith
Faculty Opinion Article
The 30
Seconds Outlook
October 15, 2009
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“[W]hen you have a large increase in government spending .
. . in a short period of time, there will be a transitory lift to GDP, but over
time the game will be reversed.”
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— Economist Lacy Hunt,
Business Spectator, October
6, 2009 |
The falling U.S dollar increases
the risk it becomes so relatively
weak that it loses its status as the
world’s reserve currency and
international currency of choice.
The Fed’s excessive money
creation has contributed to the weak
dollar, housing bubble, commodity
inflation, and the oil shock. In the
last year, the Fed purchased
$1.1trillion of mortgages and
Treasury and agency bonds, plus
direct credit and swap facilities to
financial institutions. Fed bank
credit now totals $2.2 trillion.
When the Fed basically lowered
its Fed fund rate to zero, a classic
“liquidity trap” was created. In the
typical recession, the Fed
stimulates the economy by lowering
interest rates and stimulating
borrowing and investment. But, now
the Fed funds rate is basically zero
and cannot be lowered further, thus
the economy is caught in a “trap.”
This trap led the Fed to add huge
amounts of credits to its balance
sheet.
As outlined in Seeking Alpha
(10/9/09), there are indicators of
problems with the Fed’s stimulus
strategy. One, Treasury bond prices
are increasing and yields declining,
but real yields are the highest
since the late 1980s as investors
“scratch for yield.” This behavior
reflects an expectation of
disinflation and slow GDP growth,
not a robust rebound. Two, the S&P
500’s continuing upward trend in a
weak economy suggests the declining
dollar is the driving force behind
higher asset prices, but these
prices are less high after adjusting
for the declining value of the
dollar. Three, the strong increase
in gold prices suggests investors
are making “currency trades,” not
traditional “inflation plays.”
Investors are seeking protection
from the declining dollar by buying
the classic protection in “scary
times”–-gold. Fourth, investors are
not investing in housing even with
nominal interest rates at
historically low levels. Housing is
not the same as gold as a “comfort
asset,” and current “low” interest
rates are in real terms the highest
since 1987. The “flight from the
dollar” is a huge problem that calls
for the Fed to change its strategy.
Volker found the solution during the
Reagan years.
John A. Haslem
