With The Illusion of Saving as background let me explore a very counterintuitive proposition: That the growth in the budget deficit might indirectly strengthen the dollar.
It might do so by requiring a larger capital inflow (and thus a larger current account deficit) to make up for the shrinkage in domestic saving relative to investment caused by the growing budget deficit.
Comments (0)The market is headed toward recovery, but we're not there quite yet. This was my response to CNBC's Dennis Kneale last Friday when asked, "Is the Recession Over?" The market is healing but it's not healed yet.
A substantial increase in the personal saving rate was announced last Friday to much fanfare. I hate to be a killjoy, but it was all an illusion.
The national saving rate is composed of the personal saving rate, the business saving rate, and the government saving rate. The personal saving rate is disposable income minus consumption; government saving is equal to its budget surplus. A budget deficit represents negative saving by the government.
Just to catch you up on what's been going on, I recently had two good discussions on CNBC about the Fed and the markets. On June 23rd I commented on why implementing a Fed exit strategy may be premature, and on the 24th I responded to questions about Chairman Bernanke's likely role in the BOA/Merrill Lynch affair.
The FOMC met Tuesday and Wednesday. I enjoyed two-day meetings when I was there, but we normally had only two two-day meetings per year, in February and July. The problems have grown lately and so have the number of two-day meetings.
The July meeting was usually close to July 4th-closer than this one-and the British ambassador invited us to his residence for dinner on the evening between meetings. In my first few years, Alan Greenspan sat across from the ambassador of the time, and they discussed big-picture issues very eloquently. It was educational for me as well as entertaining.
Once upon a time, people took rising interest rates as evidence of tighter money. Then, circumstances and growing sophistication led to recognition that rising inflation and/or rising inflationary expectations would show up in higher interest rates, especially longer-term rates. Then, apparently, everyone decided that rising long rates could ONLY be explained by easy money and inflationary expectations. They forgot about the tight money possibility. Sophistication crowded out the obvious.
Today's (06-23-09) Wall Street Journal editorial page, of which I'm a fan, contains a fascinating look back at the monetary policy debate in December 2003. During the FOMC meeting on December 9, 2003, then Governor Bernanke referred to a WSJ editorial of that same day (Speed Demons at the Fed) that wondered if the FOMC was paying adequate attention to "yellow-flashing" price signals such as the $406 price of gold, higher commodity prices, and a weak dollar.
In referring to the WSJ editorial and similar arguments, Mr. Bernanke said he believed such critics are "not particularly well informed" and that "as a Committee, we should continue to remain patient and not choke off growth unnecessarily."
Increased Powers for the Fed
The rhetoric so far is exaggerating the extent of new powers for the Fed. Since the major investment banks converted to bank holding companies (BHC), the Fed already is the primary regulator, at the BHC level, of the largest financial institutions. Nonbanks like AIG would represent some expansion, but even that was taken on last year on an emergency basis.
In my guest appearance on CNBC's "The Call" program Tuesday morning, the topics were "Should the Fed Stick to Monetary Policy?" and "Is the Economy Back on Track?" On the economy, I made the same point about excess reserves and the Fed's mistake regarding excess reserves in the 1930s that I made in my June 10 posting.
We get evidence frequently these days of the relative youth of those on financial television, both interviewers and interviewees. Their historical frame of reference doesn't go back very far; so they miss obvious historical precedent for contemporary issues. In my June 10 post, I discussed the Fed's ill-fated attempt to remove excess reserves from the banking system in the 1930s. In this one I feature the Fed's announcement, and the reaction to it, that the Fed would purchase longer term treasuries in an effort to depress longer-term interest rates, including mortgage rates.
Since short-term rates under the Fed's influence are near zero, a policy of targeting longer-term interest rates represents an effort to change the term structure of interest rates or the slope of the yield curve as it is usually put today. This policy is usually treated as unprecedented. Not so. A similar policy, but for different reasons, was undertaken in the 1960s and was called "Operation Twist."
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