Wednesday, October 13, 2010

"There is no limit to the dollars the Fed can create"

I read Martin Wolf’s column in the Financial Times this morning and was taken aback by what I read there. (See “Why America is going to win the global currency battle”:

Here are two quotes:

“There is no limit to the dollars the Federal Reserve can create”;


“In short, US policymakers will do whatever is required to avoid deflation. Indeed, the Fed will keep going until the US is satisfactorily reflated. What that effort does to the rest of the world is not its concern.”

In other words, “the US must win” the currency wars!

This sounds something like the fundamentalist preacher Paul Krugman who, seemingly, will never see a federal government deficit that is big enough to satisfy his tastes.

This argument is countered by Allan Meltzer, a historian of the Federal Reserve System.

“The Federal Reserve seems determined to make mistakes. First it started rumors that it would resume Treasury bond purchases, with the amount as high as $1 trillion. It seems all but certain this will happen once the midterm election passes.” (See “The Fed Compounds Its Mistakes,”

“We don’t have a monetary problem, we have 1 trillion or more in excess reserves so it’s literally stupid to say we’re going to add another trillion to that.” (This can be found at

Meltzer argues that the end to this will come through the marketplace. He states in the Wall Street Journal article:

“The market’s response to the talk about renewed bond purchases includes a 12% or 13% decline in the value of the dollar against the euro. This depreciation occurred despite a weak euro, beset by potential crises in Ireland, Greece and Spain. The dollar’s decline is a strong market vote of no confidence in the proposed policy.”

And in the Bloomberg article

“Sooner or later the bond market hawks are going to say, ‘How are they going to get rid of that $2 trillion of excess reserves?’ and the answer is they don’t know.”

The question is, in my mind, how long can the Washington policymakers hold out against the pressure of the international investment community?

In my professional experience…the international investment community always wins…it is just a matter of time!

I know that Robert Rubin is not much in favor these days, but I still believe that he was absolutely correct as the Secretary of the Treasury in the Clinton administration when he argued that the United States could not continue to create large fiscal deficits because the bond markets would not continue to support government debt issues if the deficits were continued.

President Clinton accepted Rubin’s arguments and moved to reduce the budget deficits. The result was a decline in United States interest rates and a huge run-up in the value of the United States dollar.

Rubin sensed the threat the bond market and the foreign exchange market represented to the ability of the United States government to continue along in an un-disciplined fashion.

I see no one in the United States government now that accepts the conclusion of the foreign exchange market.

My experience in business, both in running financial as well as non-financial companies, is that one ignores what the market is trying to tell you at enormous expense. I don’t know how many chairmen, presidents, and CEOs I have heard that claim that “the market just doesn’t understand what we are doing.”

Guess what?

The market does understand what you are doing and that is why it is moving against you.

I find it scary for someone to say,

“There is no limit to the dollars the Federal Reserve can create”;


“What that effort does to the rest of the world is not its concern.”

The voices of the dogmatists are getting “shrill” now. The world is not behaving according to their model. Let’s just hope that a government that does not see things going its way does not do anything rash out of desperation.

The recovery is taking place. However, it is taking place at a much slower pace than anyone wants. Maybe, just maybe, the healing needs to take its time so that a solid recovery can be attained. Quick fixes may do more damage to the patient over time than making sure that the recovery really heals the illness.

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