Monday, June 09, 2003

The FT has an interesting opinion piece on the Fed's supposed ability to fight deflation through purchasing treasuries. "For a central banker with as much respect for market forces as Mr Greenspan, the mere thought of tampering with the treasury market in this way must be a sacrilegious act. It is either testimony to how far the challenges facing the US economy have changed, or it is confirmation of a post-bubble monetary policy careering out of control." Hmm, let's hope it's the former!

When Fed Governor Ben Bernanke delivered his famous deflation address in November of last year, tipping the Fed's hand for the first time that they actually thought deflation might be something to worry at least a teensy-weensy bit about, all were quick to point out that manipulating short-term interest rates was not the only policy tool at the Fed's disposal.

Moderate measures included "lowering rates further out along the Treasury term structure -- that is, rates on government bonds of longer maturities." That's precisely what the FT piece calls into question.
"for this to be effective for more than a short period, the market has to be convinced the Fed stands to see the capping process through the maturity of the long-term bonds it wishes to target. Barring such a commitment, the Fed will inevitably become a victim of its own success. This is because the more credible this unorthodox reflationary policy, the more it tends to place upward pressure on long-term yields. It would then be a case of policy-makers succeeding in the technicalities only to fail in the broader objective."
A bit more aggressive move was "attempting to influence directly the yields on privately issued securities" by offering ultra-cheap (even 0% interest) loans to banks while accepting just about anything as collateral. The FT piece doesn't consider this direct lever over medium- and long-term interest rates. The real question here is, of course, what if private business doesn't want to borrow? At the end of the day, the Fed can't force anybody to take out a loan; it can only encourage them to do so. Overaccumulation-induced deflation is likely to dampen anybody's enthusiasm for more loans for more production for lower prices and more glut.

Even more provocative step as far as the global economy goes is to "buy foreign government debt". This smacks a bit of competitive currency devaluation to my ears and could be either totally ineffective or quite nasty in its repurcussions if not done in a cooperative international atmosphere. Bernanke mentions exchange rate policy here, too, another extremely dangerous ploy if not used wisely.

The old reliable is of course printing money like a madman. But Bernanke is careful to point out that "the U.S. government is not going to print money and distribute it willy-nilly". No matter how bad things get, finance capital will fight this kind of cheap money policy tooth and nail with everything it's got.

Inflation and deflation are not simply monetary phenomena; they are first and foremost political. Debating Fed anti-deflation policy in a political vacuum isn't going to tell us squat about what the Fed might actually do if and when forced to face the ugly facts of overproduction.


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