Your Economy (No Politics)

[sludgehound]

NYT: The Fed’s Next Move

http://www.nytimes.com/2010/10/17/opinion/17sun1.html?th&emc=th

October 16, 2010

The economy isn’t recovering fast enough. So what can the Federal Reserve do now? With short-term interest rates near zero, Ben Bernanke, the Fed’s chairman, said on Friday that he would have to use “nonconventional” tools to spur growth.
The betting is that the Fed will soon start buying up Treasury bonds to push down long-term interest rates. That would weaken the value of the dollar, increasing exports and cutting imports. The Fed’s overarching goal is to head off deflation — a sustained period of falling prices like the one that has stalled Japan’s economy since the 1990s.
Deflation is perniciously self-reinforcing. Falling prices mean lower business profits, which lead to layoffs and lower consumer spending and further price declines. It makes it more difficult to pay off debt because the value of debt rises relative to income. It provokes hoarding, as consumers, businesses and banks hold on to cash, expecting that prices will keep falling.
Will the Fed’s move, expected to be announced early next month, work? It would work far better if it were coupled with fiscal stimulus. But Republicans — who spent as if there were no tomorrow in the Bush years — have vowed to block even the most sensible stimulus programs, and Democrats have lost the will to fight. So Mr. Bernanke and the Fed are pretty much on their own.
There are risks, of course, including the risk of higher inflation down the road. But lower interest rates and a weaker dollar now should head off the even worse nightmare of deflation.
So what happens next? The Fed is expected to print money to buy bonds. That will push down borrowing rates. And that should begin to spur new spending and investment. With rates already at historic lows, any meaningful intervention will have to be at least as big as the Fed’s previous interventions in the depth of the recession, when it purchased $1.7 trillion in debt securities.
The stock market will almost certainly rise, as savers pour more money into stocks in their search for higher returns. Lower rates will also lower the cost of corporate borrowing, helping to raise profits and share prices. With consumer demand weak, companies are more likely to use their cash to buy back shares or buy other companies than to hire and invest in new factories.
That’s why, as soon as we’re past the campaign posturing, President Obama needs to fight harder for big stimulus projects — in infrastructure or alternative energy. He has to keep pushing until Congress and the public understand that without more stimulus the best that can happen will be years of only limping along. Washington needs to do more to help millions of homeowners, who can’t refinance — and take advantage of lower rates — because their equity has been wiped out.
The Fed may head off deflation. To put millions of Americans back to work, a lot more needs to be done. Mr. Bernanke can’t do it alone.

And a Pricier Renminbi
The Federal Reserve has yet to act, but officials in Europe and Russia are already complaining about the prospect of a much weaker dollar. More Fed intervention could ultimately do the global economy good — especially if it gets China to stop cheapening its currency and squeezing out the rest of the world’s exports.
A lot of countries are hurting. Very few, except the United States, are speaking out. Some governments are instead choosing to manipulate their own currencies.
South Korea has been frantically buying dollars to cheapen the won. Japan, which intervened in its market but failed to stop the yen’s rise, is now insisting that Beijing and Seoul “act responsibly.” Thailand imposed measures to stop incoming money from pushing up the already artificially low value of the baht.
Everybody can’t devalue at once. And competitive devaluations won’t change China’s behavior.
If Beijing is determined to keep its currency down after the Fed acts, it will have to buy billions of dollars of Treasury bonds and other assets — even as the dollar falls. Printing renminbi to buy the dollars would fuel inflation and bubbles in stocks and housing. Trying to avoid that by issuing bonds would also be expensive.
China has a better option: it can let the renminbi rise. Beijing’s leaders know the country needs to become more reliant on domestic income and spending. They are also fearful of any change that might have unintended political consequences. Washington’s lectures have only provoked more bluster.
The euro area of the European Union and Japan — their economies are weaker than ours and are also taking a battering from Chinese exports — should emulate the Fed, pump more money into their economies and lower the values of their currencies. That would increase the pressure on Beijing to let the renminbi rise. If they coordinated with the Fed, they could avoid sharp fluctuations among the dollar, the euro and the yen.
Other developing countries with stronger economies and higher inflation, like Brazil, would be faced with the same choice as China: inflation or letting their currencies rise. That would be painful. But if the United States slips back into recession, it will be devastating for world growth, including their own.