Dollar Slides in Wake of Fed Statement
The dollar stumbled broadly Tuesday after the Federal Reserve said it stood ready to kick-start a slowing U.S. economy.
The euro rose sharply, racking up gains of more than 1.5% against the dollar, while the greenback wilted against the yen, briefly dipping below 85 yen, considered by some analysts to be Japan's threshold for the currency's strength after last week's market intervention.
"What we see is the door being kept open to further quantitative easing," Michael Woolfolk, senior currency strategist at BNY Mellon in New York, said of the Fed's possible fresh round of economy-stimulating asset purchases.
"Quantitative easing is broadly viewed to be corrosive to a currency's value, and so with the increased probability of easing measures, the knee-jerk reaction in the market is to sell the dollar," he said.
Here is a video explaining the concept of "quantitative easing"...hang with it for a few minutes. The first part is just an introduction but it gets better. I promise!!
The euro rose sharply, racking up gains of more than 1.5% against the dollar, while the greenback wilted against the yen, briefly dipping below 85 yen, considered by some analysts to be Japan's threshold for the currency's strength after last week's market intervention.
"What we see is the door being kept open to further quantitative easing," Michael Woolfolk, senior currency strategist at BNY Mellon in New York, said of the Fed's possible fresh round of economy-stimulating asset purchases.
"Quantitative easing is broadly viewed to be corrosive to a currency's value, and so with the increased probability of easing measures, the knee-jerk reaction in the market is to sell the dollar," he said.
Gene, help me think this through...
ReplyDeleteIf the Fed prints a dollar and uses it to buy an "asset", then after the transaction the seller has an extra dollar. That's why "Quantitative easing is broadly viewed to be corrosive to a currency's value." Understood.
If the Fed prints a dollar and uses it to pay down my mortgage, then during the transaction $1 of money and $1 of debt cancel each other out. Both are destroyed by the transaction. After the transaction I have one dollar less debt and my lender has one dollar more credit available. But the quantity of money has not changed, so the transaction is not "corrosive" to the currency's value.
Is there any chance this line of reasoning is correct?
Art
Art...Be patient with me as i use a simple example to illustrate what I think you are tying to say (I concede I may not be drawing the correct conclusion)..When I teach the fractional banking system I teach it as follows. The Fed buys a bond for $1.00. A bank now has one real, physical, dollar. Assume the Res. Req is 10%, hence the money multiplier is 10 and the potential increase in the money supply is $10if the banks dont withold any of the excess reserves. Of this $10 only $1.00 is "real money" and $9.00 is credit. Now assume this $1.00 (or $10) causes enough inflation that the Fed decides to decrease the money supply by $1.00 by sellng a bond and taking the original $1.00 out of circulation. If they do that then there is still $9.00, not in money, but in "credit" that has been created and presumably cannot be retrieved by the Fed. At this point there is no real money to pay back the debt. This assumes you are sayng the money multiplier does not work in reverse, as the textbook suggests. Before I go off on any additional tangent, is this the crux of your argument on the money vs debt/credit issue? Thank you in advance for your reply... Gene Hayward
ReplyDeleteHello, Gene! I like your simple examples, by the way.
ReplyDelete1. On the difference between real money and credit -- "Of this $10 only $1.00 is "real money" and $9.00 is credit."
The thing that concerns me is cost -- interest, the factor cost of money. (Adam Smith merged capital (money) with capital (equipment), and interest with profit. But in Smith's time leverage was not so extensive, and his mistake was harmless.)
Actually, if it was only $9 it wouldn't be a problem. But as you know, total debt is 3½ times GDP. And GDP is ten times the size of M1. In other words, for every dollar of spending-money in our economy, there is $35 of debt to be paid back. That's the problem. $35 of expensive money for every dollar of "real money." ((I may be confusing M1 and base money here.))
2. Money, Debt, and Credit
If you put a dollar in the bank, and the bank puts it in the pile marked "to be lent out," then the dollar is now "available credit." If somebody borrows it, the dollar becomes "credit in use" and a debt is created.
So a dollar of credit-in-use consists of two parts -- the spendable dollar, and the pay-back-able dollar. Now to the point. You write: "... If they do that then there is still $9.00, not in money, but in 'credit' that has been created and presumably cannot be retrieved by the Fed."
Key phrase: presumably cannot be retrieved by the Fed.
My observation is that the "spendable dollar" can certainly be retrieved by the Fed, but the "pay-back-able dollar" cannot. (My comment of the 22nd highlights this problem and suggests a quick fix.)
3. Monetary Imbalance
You write: "This assumes you are saying the money multiplier does not work in reverse..."
Oh, this is good. I never thought about the money multiplier working in reverse. But I assume it does. Certainly the Fed could create a credit-crunch by raising the reserve requirement or even by selling securities, and forcing a reduction of credit in use. It might not work smoothly in reverse, but it would work.
To go back to your example: If you look at the ratio between the $1 of "real money" and the $9 of credit. you are looking at the balance between components of money. Intuitively, I expect different results from a 4:1 ratio or a 9:1 ratio or a 35:1 ratio. On my blog I keep going back to the Debt per Dollar graph because it shows the history of this ratio. And (to jump to conclusion here) the graph shows chronic imbalance leading to the Great Depression, and again in our time.
The debt-per-dollar graph shows that in fact the balance between components has changed. There is no multiplier theory involved in this, only observation.
Thank you, Gene. I hope my focus is good enough that these remarks are relevant. And I really appreciate that you make time for me. "It is astonishing what foolish things one can temporarily believe if one thinks too long alone"--JMK
Art