By Peter D. Schiff
Last week the U.S. Federal Reserve moved one step closer to acknowledging reality.
Unfortunately, it didn't let that admission move it from a policy course firmly guided by fantasy – meaning the central bank opted to stand pat on interest rates, despite the clear escalation of inflationary pressures.
In the policy statement that accompanied that decision last week, Fed Chairman Ben S. Bernanke and the other members of the interest-rate-setting Federal Open Market Committee (FOMC) took an important step in noting that inflationary concerns had taken hold in the country at large.
But as it asserted that it expects inflation to moderate this year and next, the Fed gave no indication that these heightened expectations are gaining traction within the FOMC itself. As a result – with Richard Fisher, president of the Federal Reserve Bank of Dallas, casting the sole dissenting vote – the FOMC signaled no likelihood that it was actually prepared to do something to fight a problem that it doesn't really seem to believe exists in the first place.
In fact, by indicating that it expects inflation to moderate, the Fed is effectively saying that the elevated expectations are unwarranted. In other words, Bernanke claims that despite the fact that so many people are carrying umbrellas, he still believes it will be a sunny day. The takeaway from the statement is that no rate hike is forthcoming.
The markets saw this position for what it really is – a capitulation to inflation and to a weakening dollar. No surprise then that gold responded with the biggest-single-day gain in more than 20 years!
Those Missed Opportunities…
With the ensuing carnage on Wall Street, many Thursday-morning quarterbacks claimed the Fed missed an opportunity to reverse the dollar's slide by either talking tougher or perhaps actually raising rates by a quarter percentage point. If the Fed really believed it could "jawbone" the dollar higher, or that a small rate hike would do the trick, policymakers would have given it a try. I believe they chose a dovish route because of a greater fear of having a hawkish stance casually disregarded. Imagine what would happen if the Fed raised rates and the dollar kept falling? It would be like one of those horror movies where someone holds a crucifix up before an advancing vampire, only to have the Count sweep it aside without so much as a cringe.
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Some observers claim that now is the time for a coordinated central bank intervention to reverse the dollar's decline. Those who place their faith in such a plan overlook the fact that Asian and Middle East central banks have been unsuccessfully intervening on the dollar's behalf for years. Nations that maintain dollar pegs must constantly intervene in the foreign exchange markets by buying dollars to keep their own currencies from rising in value. Over the past few years the scope of this intervention has been unprecedented, with foreign central banks accumulating trillions of excess dollar reserves. Yet despite these misguided, Herculean efforts, the dollar has fallen drastically.
Help From Across the Pond?
Intervention advocates must believe that if the European Central Bank (ECB) and a few other central banks joined the fray, that a better outcome would be achieved. However, any additional efforts to artificially prop up the ailing dollar will be equally ineffective.
Even if ECB intervention could slow the dollar's descent, what possible reason would the Fed's European counterpart have for doing so? The ECB is already concerned about inflation and is. Intervention to support the dollar would only worsen Europe's inflation problem and run counter to these efforts. To buy dollars, the ECB must increase its own money supply. That is exactly what is happening in countries like China and Saudi Arabia, which is why inflation in those nations is already much higher than it is in Europe.
Further, since the ECB is asking Europeans to endure higher interest rates to fight inflation in their own backyard, why should Europe's citizens have to make additional sacrifices to help Americans fight inflation in the U.S. market? Indeed, that would be an especially tough sell given that the U.S. central bank has held this economy's benchmark interest rate at the ridiculously low level of 2%, and has effectively excused Americans from the conflict.
Since we can't count on any help from our friends, the only option would be for the U.S. Treasury to intervene unilaterally. However, the U.S. government should think twice about bringing a knife to a gunfight. The Treasury only has about $75 billion in foreign currency reserves with which to intervene. That "war chest" would make about as much difference as adding a raindrop to the Atlantic Ocean.
To put that U.S. currency-reserves figure in some perspective, consider that Poland has $77 billion, Turkey has $78 billion, and Libya has $79 billion. On the other end of the spectrum, China has $1.7 trillion (not counting Hong Kong's own $150 billion), Japan has $1 trillion, and Russia has $550 billion. India and Taiwan each have about $300 billion. Singapore, a nation with fewer than 5 million people, has $175 billion.
In fact, the United States holds just about 1% of the world's $7.6 trillion of foreign currency reserves, and our total position amounts to just 2.5% of the total daily volume of foreign exchange trading. Talk about Bambi vs. Godzilla!
Here's the bottom line: If the U.S. dollar is going to fall, the U.S. Treasury is completely powerless to do anything to stop it.
[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a regular contributor to Money Morning, and most recently wrote about . For a more-detailed analysis of the nation's financial problems, and the inherent dangers that these problems pose for both the U.S. economy and for dollar-denominated investments, click here to download Euro Pacific's new financial-research report, " ." The report is free of charge.]
News and Related Story Links:
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Fed Holds Rates Steady in Face of Upside Inflation Risk.
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