[R-G] The Fed Sinks the Dollar

[Anthony Fenton]

  May 1, 2008
The Price-Wage Squeeze
The Fed Sinks the Dollar
By MICHAEL HUDSON
http://counterpunch.com/hudson05012008.html

Against the recommendations of most economists and even the Financial  
Times of London, the Federal Reserve Board yesterday cut its discount  
rate by yet another quarter-point, to just 2%. Ostensibly, the  
intention is to try and spur economic “recovery” – as if a cut in the  
interest rates would do this. At first glance this seems to reflect  
the Fed’s ideology that manipulating the interest alone can expand or  
contract the economy – as if it is like a balloon, with its structure  
is pre-printed on it, to be inflated or deflated at will to control  
the level of activity.

This simplistic philosophy was a hallmark of the Greenspan era.  
Changing the interest rate alone meant that the Fed didn’t have to  
“think,” didn’t have to regulate markets, raise reserve requirements  
on bank loans to fuel the asset-price inflation that the Fed confused  
with real “wealth creation.” It didn’t have to regulate subprime  
lending or rain in widespread financial fraud. All it had to do was  
raise interest rates when this gave banks an opportunity to charge  
more and increase their earnings – or cut interest rates to lower cost  
of bank borrowing from the Fed.

But surely not even the ideologically hide-bound Federal Reserve can  
still imagine that a structural problem – the looming depression from  
the Fed’s favoritism to the banking sector promoting de- 
industrialization of the economy – can be solved by lowering interest  
rates yet again. While the Fed lowers its rate for lending to banks,  
these banks have not been passing on the rate cuts to their customers.  
Credit card rates are going up, and entire Christmas trees of  
penalties are further increasing banks’ rake-off. Mortgage rates  
remain high, so that real estate markets remain in the doldrums. The  
banks simply are not lending.

What they are doing is speculating, above all against the dollar. They  
thus are emulating what Japanese banks did after that nation’s  
financial bubble burst in 1990. Japan’s banks became the most active  
players in the international “carry” trade: borrowing at very low  
interest rates in a weak currency (the yen after 1990, the dollar  
today) to lend to high-interest borrowers, preferably with strong or  
at least stable currencies (such as to Iceland before it became so  
debt-ridden that its currency began to collapse last year; and today,  
the to European borrowers in euros).

So fiat US credit is being directed to Europe. US banks create or  
borrow credit at 2%, and lend it out at 6% or more – and get a  
speculative foreign-currency gain as the euro continues to rise  
against the dollar.

The aim evidently the same as it was in Japan after 1990. Many banks  
are nearly insolvent as a result of the b ad real estate loans on  
their balance sheets. To rescue them (so that it is not necessary to  
nationalize them, as England recently had to do with Northern Trust)  
is to help banks “earn their way out of debt” – by making profitable  
loans.

But bank lending and profitability has become decoupled from the  
economy at large. Banks are not lending to finance tangible capital  
investment and new hiring. Helping them thus does not help pull the US  
economy out of the deepening depression. (A recession is short and is  
followed by recovery. Today’s looming economic depression is headed  
toward a widespread forfeiture and transfer of property from debtors  
to creditors.)

The ultimate effect is to inflate the power of finance, credit and  
real estate relative to labor’s wages and industrial capital. This is  
not a way to encourage new tangible investment. It is just the  
opposite of Keynesianism. Rather than signaling “euthanasia of the  
rentier,” it is empowering finance and applying euthanasia to labor  
and industry.

And to Europe, I should add. The Fed’s act to subsidize U.S. bank  
lending to Europe will help raise the euro’s exchange rate relative to  
the dollar. This will be a boon to currency speculators. And it will  
help keep the price of oil and food down to European consumers. But it  
also will raise the price of European labor and other domestic costs  
(including the cost of real estate, which is playing a rising role in  
employee budgets throughout the world). This will tend to make  
European exports even more expensive in global markets – including the  
Airbus, much to the joy of Boeing, and European autos, much to the joy  
of GM and Ford. (No wonder Kirk Kirkorian recently began buying back  
into the U.S. auto industry.)

In the 1930s, countries competed with one another by imposing rival  
tariff walls and non-tariff trade barriers (led by the United States)  
and “beggar my neighbor” currency depreciation (again, led by the  
United States). But European central bankers for their part are so  
brainwashed with modern Chicago School monetarist ideology – and so  
unaware of their own continent’s economic history – that they pursue a  
knee-jerk reaction to domestic inflation by raising interest rates.  
This merely increases their currency value all the more, attracting  
yet more foreign “carry trade” loans. (Economists call this a  
“backward bending demand curve” and find it an “anomaly,” as they find  
most reality to be these days.) So while U.S. monetary policy helps  
subsidize the banking system relative to the industrial sector and  
labor, European monetary policy goes along with today’s parallel- 
universe thinking and undercuts its own industry.

An innocent victim of the dollar depreciation caused by the Fed’s  
action will be Third World food-deficit countries whose currencies are  
tied to the dollar. Latin America, much of Africa an Asia will find  
that in their currencies the price of raw materials denominated in  
euros will rise.

But their domestic wages and other income for the population at large  
are not increasing. The wage-price squeeze will go on – while their  
oligarchies no doubt contribute by joining the speculative outflow  
into hard currencies by moving their domestic funds offshore.

Michael Hudson is a former Wall Street economist specializing in the  
balance of payments and real estate at the Chase Manhattan Bank (now  
JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson  
Institute (no relation). In 1990 he helped established the world’s  
first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was  
Dennis Kucinich’s Chief Economic Advisor in the recent Democratic  
primary presidential campaign, and has advised the U.S., Canadian,  
Mexican and Latvian governments, as well as the United Nations  
Institute for Training and Research (UNITAR). A Distinguished Research  
Professor at University of Missouri, Kansas City (UMKC), he is the  
author of many books, including Super Imperialism: The Economic  
Strategy of American Empire (new ed., Pluto Press, 2002) He can be  
reached via his website, mh at michael-hudson.com