On Printing Money and Debasing The Currency

“The issue of the renminbi is one that is an irritant not just to the United States, but is an irritant to a lot of China’s trading partners and those who are competing with China to sell goods around the world. It is undervalued. And China spends enormous amounts of money intervening in the market to keep it undervalued.”

-Barack Obama at the closing of the recent G-20 meeting in Seoul

If I asked any Federal Reserve or Treasury official, "would you prefer the US dollar to be higher or lower against China’s currency?" what do you think the answer would be. How about this question: "If you could snap your fingers and depreciate or appreciate the US dollar against a basket of currencies, which would you prefer to do?" Here’ s another one: Would you mind it if the EURUSD rate settled back toward purchasing power parity, which would have the dollar rising some 20% against the euro?

Do I have to get the Nicholson clip out again? Tim Geithner is fooling no one when he says the US is not trying to weaken the dollar. Of course it is.

Now, if the US had interest rates at 4 or 5 percent instead of zero percent or if fiscal policy weren’t dead, we wouldn’t see the Fed doing quantitative easing. Instead the Fed would be acting to supplement fiscal policy, using ‘conventional monetary policy’ to boost aggregate demand, which means lowering the Fed Funds interest rate. The effect on the exchange rate of this policy response is to weaken it. But, of course, rates are zero percent, not 4 or 5 percent. So the Fed is forced into QE.

Does quantitative easing debase the currency? No.

QE doesn’t work. Philip [Coggan] notes that US long-term rates were higher when they finished QE than when they began. Money supply (estimated M3) was lower afterwards than before. Rates only started dropping when QE stopped. QE is just an asset swap that drains income from the real economy.

More on the Federal Reserve and Quantitative Easing

But that doesn’t mean the Fed isn’t trying to debase the currency. It’s just that the Fed doesn’t understand credit. QE won’t work unless you get some sort of feed through into credit growth.

“Like gold, 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.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).

— Ben Bernanke, National Economists Club, Washington, D.C. November 21, 2002 Federal Reserve

What about money printing? Is the Fed just printing money? Yes. That’s what expanding its balance sheet means. It is creating previously non-existent dollar credits out of thin air and placing them on its balance sheet to buy financial assets.

I liked Ed’s piece on QE called Does Ben Bernanke Believe The Stuff He Writes?. What caught my eye was his line, "As for monetary policy, while QE does not create new net financial assets, it is money printing because it is a swap of bonds for electronic credits of equivalent value i.e. money. The Fed is effectively ‘monetizing’ the government’s debt." Under that definition of money he is correct. But my point below will be that functionally it doesn’t do much of anything for aggregate demand.

As any student of Economics 101 realises, you can control the price of something, or the quantity, but not both simultaneously.

Amateur Hour at the Federal Reserve, Marshall Auerback

I am talking about base money, of course. Marshall is concentrated on broader money aggregates and credit. The problem we both see is the credit feed through mechanism. QE is a supply side solution to a demand-side problem. It is the demand for credit by creditworthy customers which is keeping credit growth subdued. And no amount of money printing will change this. OK, maybe $8-10 trillion will, but is this what you want?

currenciescurrency warsmonetary policymoneyquantitative easing