Friday, February 25, 2005

Yesterday, Brad Setser wrestled with Stephen Jen (a cage match no doubt) and came out saying,
Tis true that most countries in the world would rather not see their currencies appreciate against the dollar.

``It's in nobody's interest for the dollar to fall,'' said Jen. ``The Europeans are clear they don't want to see the dollar fall further, so are the Japanese, and now the other Asian countries are saying it.''

But if nobody's currency appreciates against the dollar, the United States' need for external financing is likely to keep on going up along with the expanding US trade deficit. The real question continues to be "who is willing to finance the US in order to keep their currency from appreciating?"
My guess is that Jen among others is counting on dramatically higher US interest rates -- rather than a dramatically weaker US dollar -- to do the work of cutting US imports and putting the world on the long road to rebalancing.

That being said, Stephen Roach worries today that the Fed is just not up to the task of draining the global liquidity pool which it filled itself.
The issue is not whether the Fed should take the funds rate back to its neutral setting � or even into the restrictive zone if it wishes to cool the economy. That is imperative, in my view. The question is whether the Fed will engineer such a tightening. As much as I hate to say it, I do not think that this Fed has either the courage or the political will to pull off such a maneuver. The logic hinges on my belief that the Fed has thrown its full weight of support behind the Asset Economy � an economy that is built on a false foundation of unsustainably low real interest rates.
The Fed seems to care very little for runaway asset inflation. It's only consumer price inflation they seem to care about, and that is still under control, driven primarily by rising global commodity prices than US consumer strength. From everything Greenspan has said and done since 1997, I have to agree with Roach.

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