The dirty secret of the Federal Reserve is that it’s engaging in a surreptitious currency war, using quantitative easing to depreciate the currency.
In September the Fed switched from talking about what it’s doing – that is, the amount of QE – to talking about its goal instead – that is, lower unemployment. It said it would just keep expanding its balance sheet at $40 billion a month 'til that happens.
Economists and investors I’ve spoken to in New York over the past week agree that the unspoken aim of Fed policy is actually to get the currency down. Cheap, easy money won’t, on its own, achieve the goal of lower unemployment, but a depreciating currency will. It is also the only way of achieving President Obama’s goal, announced in January 2010, of doubling exports within five years (although cheap gas has since emerged, which is certainly helping).
So the US is engaging in a currency cold war; what does that mean for countries like Australia?
Because it is trying to reduce the world’s reserve currency, the Fed is effectively giving other countries two choices: either allow your currencies to appreciate against the US dollar and thus make your economies less competitive and crunch your export industries, or print money with us and risk (or perhaps guarantee) inflation.
It is a Hobson’s Choice, and like most other countries’ central banks, the Reserve Bank of Australia doesn’t quite know what to do.
Well, actually it knows it should get the Australian dollar down but is shy about intervening directly so is trying to do it by cutting interest rates, which won’t work because there is still too big an interest rate gap and there will be unless the Reserve Bank cash rate is cut to about 2 per cent.
Australia is in the same bind as every other country, faced with a choice between inflation and uncompetitive export sector – because the world’s reserve currency is being deliberately depreciated.
If the Reserve Bank keeps cutting, inflation is guaranteed; if it doesn’t, the ruin of Australia’s manufacturing and tourism sectors is guaranteed.
For Australia the problem is compounded by the very large flow of safe haven capital inflow now arriving, which is largely blind to interest rates. Money is pouring into Australian dollars, including from other central banks, seeking the security of our AAA rating. That’s making the exchange rate immune from domestic monetary policy.
What to do?
The answer, surely, is to give up and put the money to good use replenishing the national infrastructure.
Rather than wringing our hands about the capital inflow, why not give global investors something to invest in other than Aussie government bonds and export LNG projects?
Specifically – infrastructure bonds to finance a huge national building programme of roads, ports, bridges, airports using money borrowed at super low rates to take advantage of this once-in-a-lifetime opportunity.
It would assist the non-mining economy of the eastern states, cushion the transition from the peaking of the mining investment boom and set Australia up for the future.
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