Wednesday, October 20, 2010

Ben and Tim: Part I

We have been living with the team of Ben Bernanke and Tim Geithner since 2006, Bernanke as Chairman of the Board of Governors of the Federal Reserve System and Geithner as the President of the Federal Reserve Bank of New York. The only person now missing from this team is Hank Paulson, who was Secretary of the Treasury until Geithner moved into that position.

During their partnership, there has been a failure to recognize the clouds that were forming in the 2006-2007 period. We have the flooding of the banking system which took place beginning in the fall of 2008. And, now, we have the sinking of the United States dollar.

It was very disingenuous of Treasury Secretary Geithner to claim yesterday that he…and the United States government stood for a “strong dollar” and “will not engage” in currency devaluation.

This stance has been taken by the United States government and every Treasury Secretary since the dollar was floated in August 1971.

Yet, the value of the dollar has fallen by around 30% on a trade-weighted basis against major trading countries since this index began in early 1973. The value of the dollar on the same basis has fallen by about 11% since March 2009.

And, where do we stand policy wise? The deficit of the United States government has fallen to $1.3 trillion in fiscal year 2010, down from $1.4 trillion in fiscal year 2009. My estimate of the cumulative fiscal deficit for the next ten years, assuming the current philosophy of government (which is the same philosophy of government that has been around since the early 1960s), is at least $15 trillion.

Monetary policy? Well, the Ben and Tim team gave us a Federal Reserve balance sheet that more than doubled to over $2 trillion from about $0.9 trillion in August 2008. Now, Chairman Ben is making noises that could lead to an increase in this balance sheet to over $3 trillion in the next year. And, with federal deficits over the next ten years that could total $15 trillion or more, it is hard to see how this balance sheet could decline by much.

The basic crisis philosophy of the Treasury and the Federal Reserve since the fall of 2008 has been to throw as much “spaghetti” as they can against the wall to see what sticks. That policy still seems to be alive and well within the halls of the Federal Reserve and the Treasury.

This approach to policy making is what international investors are concerned about at the present time.

A complicating fact relating to this picture is that the world is splitting into two camps. There is the dollar/Euro camp that is composed of the developed countries in the world who are still battling to get their economies moving again. (Note that the dollar/Euro camp is split as well. See “Fed’s Strategy Will Bring Euro Victory Over the Dollar,”

And, there is the camp that includes the rapidly emerging nations (including some others) that are experiencing relatively high rates of economic growth.

This bifurcation into the two camps is causing and will continue to cause world trade and finance pressures going forward. There may not be any change for some time about the place of the United States dollar as the world’s reserve currency. But, if the scenario presented above actually occurs, the pressure on the dollar will just continue to grow with time.

At this point I won’t get further into this discussion for the focus today is on Ben and Tim.

Why is it that I have so little confidence in the future of the economic policy of the United States government at the present time. Bernanke has been in a leadership role around Washington since 2002. Everything he has been connected with has not turned out particularly well with the exception of his ability to throw “spaghetti” against the wall. Geithner is the only senior economic advisor of the Obama administration that was with the administration at the beginning and still remains. What interpretation can be put on this survival?

Who knows, maybe Ben and Tim will go down in history as the team that saved the economy but sank the dollar.

I don’t know when in my professional career that I have been so nervous about the economic leadership in this country. My impression is that many others feel the same way I do and much of this feeling is getting reflected in the value of the United States dollar. Thus, although the value of the United States dollar will vary from time-to-time, I see no reason to believe that this value will not continue to trend downwards over the longer term.

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