Federal Reserve Will Think and Then Think Again!

By tothetick

Paul Fisher, Head of Markets at the Bank of England told the economic worriers of the UK that the BoE would not pull the stoppers out on the economic stimulus plan in the UK and that the “macroeconomic outlook here is not as bright as in the US, therefore we are some way behind them in terms of return to anything like trend growth”. Has Mr. Fisher been to the US recently?  Bright?

It looks like the stimulus plan in the USA might not be easing either and the Federal Reserve is going to have to think and then they are going to have to think again. Everything points to the fact that the economy is not doing quite as good as Mr. Fisher seems to believe at the BoE. Trouble may be lurking around the corner as well with regard to currency strife in markets around the world, in particular those that are emerging countries. That could turn out to be the real reason why Bernanke has to think and then think again.

We have been interlinked for decades. That’s what we wanted. But that means the US doesn’t have full control of what’s happening either. Emerging countries have hoards of US Treasury bonds today acting as buffers and capital insurance for their economies. If emerging countries and countries in economic difficulty have a sudden fall in investment, then they are going to get worse. They have understood that and have bought into US Treasury bonds (bout $3.5 trillion according to the International Monetary Fund) to make sure that if they are left in the lurch by investors, then they will still have something to back them up. There are some $7.2 trillion in reserves around the world right now either in Dollars or in Euros. You can add on top of that some $8 trillion that has gone into emerging markets since the early 2000s, in the hope of making a quick buck.

The Treasury bonds from the US in those reserves are all over the world, from China to Russia as well as the Middle East and Latin America. If currency reserves in those countries start to run into trouble, then the Treasury bonds will go on sale to get hard pushed cash to stabilize those emerging economies. The consequences could be catastrophic. It wouldn’t just be the death of the dollar because the Chinese have a stronger currency, but it could mean the death of the dollar because of the Treasury-bond sale and increased interest rates in the US. US Secretary of the Treasury (1999-2001) Larry Summers once said that all of this was “mutually-assured financial destruction”. Is that where we are headed?

Will the Federal Reserve be able to carry on regardless and cut the stimulus plan from under the feet of the economy in the light of the possibility that it will lead to a worsening in the situation of other countries that hold large reserves of the dollar? Is the US able to sustain that if it happens? Won’t the Federal Reserve have to rethink its plan for the moment? If the US is stable and it destabilizes the economic growth of emerging countries around the world, then won’t that lead to self-destruction by the sale of the Treasury bonds?

The Federal Reserve has a tough time on its plate and its work will definitely be cut out to deal with domestic inflation and unemployment rates (especially for the youngsters). Pile on top of that the trouble with how to keep the banks on a stable footing. The Federal Reserve needs an extra hand to juggle all of that and now someone has thrown the currency problem right into the middle. Catch, Bernanke!

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