THE FED’S BIG DOLLAR GAMBLE

2/22/13

There are two side effects of the Fed that needs to be discussed —prospective currency wars with some major trading [partners and a reduction in the federal budget deficits—are far less known.
The first side effect, currency wars, is an example of how something good—stimulating our economy by lowering interest rates—can have a downside. As it has weakened the dollar against the currencies of many of our major trading partners. A gradually declining dollar encourages job growth in our country by making our exports cheaper and our imports more expensive. The dollar has dropped more than 10% against the currencies of our major trading partners since 2009, when the world financial crisis was in full swing and the Fed invented one program after another to drive down the interest rates.
US manufacturing is showing signs of recovery in part because the dollars decline had made domestically produced products more competitive with foreign products. But what’s good for us is bad for countries whose products are being priced out of our market and are being forced to compete with cheaper US goods.
Japanese PM Abe, is pushing his country’s central bank to run down the value of the yen as p[art of his economic stimulus program. China is thinking along similar lines, Germany is pushing programs that are nominally aimed at economically struggling euro countries.
The dollar is the world’s reserve currency, which allows us to suck in money form all over the world to fund our trade and budget deficits without having to balance our accounts. There’s a tension between our internal situation a lower dollar is good and our role as a reserve currency (a dollar that falls too rapidly risk spooking investors and costing us our reserve currency status).
The second side effect of the Fed’s low-rate policies helping finance our federal -budget deficit is an unalloyed good thing. Last year the fed says it made about $91 billion in profits and sent $8839 billion of that to the Treasury.
The fed has been buying Treasury and mortgage backed securities by the boatload in order to raise their prices, which has the effects of driving down interest rates.
The fed bought these securities with money that it essentially created out of thin air and then credited to the fed accounts of the financial institutions that sold the securities. The fed pays nominal interest on the money that sellers leave in those accounts and no interest o the money with drawn form them for other purposes. The fed collects interest on the securities it has bought. Thus expanding the portfolio has been hugely profitable. The fed projected purchases of about $540 billion of treasury securities this year will indirectly fund about half of this year’s federal budget deficit. It can’t indefinitely withstand –pressure form financial markets and form other central banks. When the fed’s inevitable dial back kicks in the dollar will rise and fed profits and remittances to the treasury will fall. The bottom line: Pharmaceutical stimulus is forever. But fed stimulus isn’t
Source fortune, allan sloan

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