How the Threat of Monetary Inflation Keeps a Currency Strong
Here’s the latest from The Telegraph:
Drip after drip of deflation data… Today’s release on manufacturing activity by the Richmond Fed is pretty ghastly, as you would expect given that the effects of fiscal stimulus are now wearing off at an accelerating pace – before the happy handover to the private sector is safely consummated – and given that the structural East-West imbalances that lay behind the global crisis are getting worse again… This follows yesterday’s horrendous fall in the Texas business activity index from the Dallas Fed, which fell from -4 in June to -21 in July. “Thirty-one percent of firms reported a worsening of activity, up from 22 percent in June,” said the bank. Texas New Orders were -9.6 in July, -8.2 in June, and +15.8 in May. Capacity Utilization was -0.6 in July, +2.7 in June, and +18.7 in May. This of course is why Fed chair Ben Bernanke has been giving strong hints of QE2 (helicopters again) if necessary.
Here is where it gets so interesting we can barely sit still. Ben Bernanke is threatening to drop money from helicopters (quantitative easing). In a better world, a banker who threatened to inflate the currency would be punished immediately. People would take him at his word. They would dump his paper money immediately. The price of it would drop. He’d be forced to protect it.
But this time it really is different. As Ben Bernanke himself put it, even the “credible threat” of monetary inflation by the central bank should be enough to cause people to want to spend paper money rather than save it. Thus, Bernanke promised, he can always speed up the velocity of money and thereby bring about a boom, of sorts, simply by threatening to drop money from helicopters.
But lately he threatens. And still the dollar holds firm. Why? Because the threat is not credible.
Oh what a wicked twist of fate. What has this world come to when a central banker cannot roll the currency markets and whack speculators?
Usually, central bankers are careful to give the impression that they will protect their currencies. Even while they are actually undermining them with monetary inflation. Investors catch on after they’ve been shellacked a couple times. Then, the central banker loses credibility and the currency falls.
But this time, Ben Bernanke actually wants investors to believe he WILL undermine the dollar. He wants to stimulate spending and investing by encouraging people to get rid of greenbacks rather than save them. But people don’t believe him.
Inflation is only really a threat, we conclude, when central bankers are pretending to prevent it…not when they’re trying to cause it.
But why won’t Ben Bernanke drop money from helicopters? Because he’s got a rope around his neck…and it’s getting tighter. As long the US can finance its deficits at low interest rates, he can’t move. It’s uncomfortable, but it’s a damned sight better than hanging. More on this as we figure it out.