Chart: US Dollar Index 9/28/2007
Is the FED is attempting to head off deflation by devaluing the dollar? DISCOUNT and FED rate cuts in conjunction with dollar devaluation are classic tools used to fight deflation before it starts paradigm as outlined by Bernanke in his 2001 speech. In that speech Bernanke suggests that rates could be cut to zero, and if that fails other measures could be taken by the FED to stave off deflation at any cost. He also says that FED could attempt to put a peg or cap on Treasury bond prices and yields of all maturities. He even recommends that FED purchase private debt and Dept of Treasury purchase private assets that then could be offset by corresponding Fed purchase of Treasury Debt. Of course, full monetization is an option that is ultimately available.
Dollar devaluation is another option that can also be used to ward off deflation as explained by Bernanke:
U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation
This is no longer a theoretical example, this is in fact what the FED has done by signaling it unwillingness to support higher dollar.
But, in my opinion I don’t think that these FED liquidity injections and higher prices in dollars(devaluation) will work to induce inflation without ameliorating increases in wages – which by the way will not sufficiently increase for lower and middle classes --to offset rising costs. In the 1970’s women went to work and total household income went up along with savings and consumption.
The chart above illustrates that despite high inflation, US Personal Savings averaged 9.8% from 1971 through 1980. From 2000-2004, the savings rate stayed slightly higher than 2.1%, however US Savings rate has been less than 1% since 2005.(Table 1)
NIPA, calculates savings as Disposable Income (Income less taxes) less Personal Consumption. If the cost of Personal Consumption increases due to dollar devaluation as it will cost more dollars to buy same goods, either personal consumption has to decline or wages have to increase. Employers faced with rising costs of imported materials and goods will also see their profits decrease, which is going to further damper capital spending of domestic companies. While it is generally thought that US global corporations should benefit from lower dollar for price-competitive reasons, this might not be enough to offset loss of income and jobs from companies whose markets are primarily domestic.
There is a large degree of risk that dollar devaluation will raise prices of goods without corresponding increases in wages to support past levels of consumption. While cuts in FED and DISCOUNT rates serve to theoretically stimulate consumption--with an effective savings rate of nil-- rising prices for goods as a result of dollar devaluation seems like a confounding move.
Edited by linrom1, 01 October 2007 - 11:30 PM.
