Historic QE2 to the tune of at least $500BB will degrade the US dollar by as much as 20% and cause a currency war


The Fed is poised to make the "biggest decision in decades" as Robin Harding reported in the FT this morning.  The Fed will likely announce an initial purchase of $500 Billion dollars in long term US treasuries.

The real question is how quickly that purchase will come. The treasury already purchases $30 BB in Treasuries every month just to keep their current balance sheet size the same with the continued runoff of MBS assets, otherwise now known as QE1 via FT:
“Given the committee’s objectives, there would appear, all else being equal, to be a case for further action,” as Mr Bernanke put it in a recent speech in Boston.

That case is unlikely to be derailed despite opposition from some on the FOMC who feel that the risks of QE2 are too great. Thomas Hoenig, president of the Kansas City Fed, has said that looser policy is a “dangerous gamble” and is certain to vote against. Three other non-voting members are definite opponents, while several more have reservations.

Rather than a huge programme of asset purchases all announced up front, the Fed has made clear that it wants QE2 to evolve in size depending on the economic data. But it is still likely to make a downpayment by pledging at least some asset purchases on Wednesday: $500bn is a likely figure for this initial round of buying
Bill Gross, who seems to be against the QE2, has said that QE2 could debase our dollar by up to 20%.  If this cuts the value of the dollar by that much, prices on imports become that much more expensive.  So does gold and oil. 

The unspoken problem with this is that it also debases the value of the dollars that you have in your bank account by 20% and it also debases the value of the reserves of countries that hold those dollars, via CNBC:
"I think a 20 percent decline in the dollar is possible," Gross said, adding the pace of the currency's decline was also an important consideration for investors.

"When a central bank prints trillions of dollars of checks, which is not necessarily what (a second round of quantitative easing) will do in terms of the amount, but if it gets into that territory—that is a debasement of the dollar in terms of the supply of dollars on a global basis," Gross told Reuters in an interview at his PIMCO headquarters.
Others think that the debasing of the currency will lead to the death of the current dollar regime and replace it with something much less favorable. If that does happen, it could lead to huge misallocations of capital as the world has to exit their dollar positions and the US gets flooded with dollars that central banks no longer want. 

Or if you think about it another way, keeping dollars in central bank reserves allows countries to avoid keeping those dollars in circulation and thereby avoiding having those dollars go towards purchases of goods and services.  The huge current account deficits in the United States, are also huge capital account surpluses.  If countries did sell off their reserves en masse, it would force people everywhere to have to actually buy dollar denominated stuff with them pushing down the current account deficit. 

But all those people competing to buy stuff in dollars, also means prices on goods will get more expensive causing inflation, via Telegraph:

The Fed's "QE2" risks accelerating the demise of the dollar-based currency system, perhaps leading to an unstable tripod with the euro and yuan, or a hybrid gold standard, or a multi-metal "bancor" along lines proposed by John Maynard Keynes in the 1940s.

China's commerce ministry fired an irate broadside against Washington on Monday. "The continued and drastic US dollar depreciation recently has led countries including Japan, South Korea, and Thailand to intervene in the currency market, intensifying a 'currency war'. In the mid-term, the US dollar will continue to weaken and gaming between major currencies will escalate," it said.
More

The Fed QE2 bill could be $1TT, while credit losses in private banks could face losses up to $15TT
Five_Questions_for_the_Fed on the eve of QE2
Busch:  The real reason for QE2 is to drive down the dollar

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