Tuesday, December 7, 2010

The US Dollar

The Bloomberg U.S. Dollar Index was reported to have increased by 5.08% in the month of November. This refers to the value of the dollar against a basket of widely traded currencies.  What's happening?  In an earlier blog, I wrote that the Fed's purchase of $600million of Treasury bills is inflationary and debasing, even though the money came from reserves and was not 'printed', as some have incorrectly claimed. 

Given the rise in the Index, the temptation is to concolude that the Fed's action will therefore positively pump consumption without inflation, notwithstanding the fact that fear of the future is damping consumption, regardless of the amount of money in circulation.  While inflation in the immediate future does not look likely, pouring that much money into an economy will have two effects: increase the cost of national borrowing as lenders risk adjust their rates to account for the increase in money supply, and reduce the incentives to get tough on government spending, the only sustainable way to reduce budget deficits. 

Regardless, the rise in the dollar index is unlikely due to sentiment that the U.S. economy is strong but rather fears of a Euro meltdown given by Ireland's, and possibly Spain's, economic crises.  As we have learned from the Asian currency crisis, contagion is real and that justifiable fears of contagion in the EU, stemming from Ireland, are likely the sources of the flight from Euros to Dollars.  All this to say that policymakers need to maintain vigilance on non-productive domestic (i.e., government) spending and not use the relative weakness of the Euro as a hedge against wrong headed monetary policies.

No comments:

Post a Comment