Etaoin
12-10-2002, 08:43 PM
The Daily Reckoning PRESENTS: Print it! Money, that is. The
Fed's implicit pledge to crank out as many new dollars as
needed to stave off deflation makes foreign currencies and
inflation-protected Treasury notes all the more attractive.
Paul Kasriel wonders how creditors of the world's largest
net debtor nation might react.
INFLATIONISTAS AT THE HELM
By Paul Kasriel
"World's largest debtor [U.S.] pledges to pay you back in
cheaper dollars." In effect, this is what one of the rookie
members of the Federal Reserve Board, Ben Bernanke,
announced to the world on November 21. He said that the Fed
had the tools, and the talent, to borrow a line from that
cinema classic, "Ghostbusters," to print unlimited supplies
of U.S. dollars. So fear not deflation. The Fed has
implicitly pledged, to its dying breath, that it will crank
up the currency printing presses to prevent it.
Now, I find it remarkable that a representative of the
central bank to the world's largest net debtor nation
would publicly make such a pledge. I don't, however, find
it remarkable that this central bank would privately harbor
such thoughts. After all, isn't a little (or maybe, a lot)
of inflation what debtors want to bail them out of their
financial obligations? Doesn't it imply less of a cut in
your standard of living if you can pay back some
unsuspecting sap in dollars that buy less?
As a nation of net debtors, we want inflation. And this
Fed, unlike the one guided by an "old era" central banker,
William McChesney Martin, aims to please its domestic
constituency. If inflation is what it wants, inflation is
what it will get. (Incidentally, Japan is a net creditor
nation. Creditors, especially those whose credits have
little default risk, generally would opt for falling prices
of goods and services rather than rising prices. Might this
have something to do with the rest of the world being in a
tizzy over Japan's falling CPI, while the Japanese
citizenry is less concerned?)
Currently in the U.S., you can earn about 1&3/8% on three-
month "wholesale" bank deposits. The October reading on the
year-over-year change in the U.S. CPI was 2.0%. So,an
investor is receiving a negative "real" return on this
investment to the tune of 60 basis points. A global
investor could do better by holding comparable paper
denominated in other currencies. For example, at the
beginning of this week, three-month money denominated in
pound sterling was yielding 1.64% after subtracting the
U.K. October inflation rate. That's an inflation-adjusted
pickup of 229 basis points over a three-month U.S.
investment.
Heck, even in Japan, where three-month rates are hovering
just above zero, you can earn a deflation-adjusted return
of 0.76% - a 141 basis-point pickup over dollar-denominated
money. And if Governor Bernanke has anything to say about
this, the odds are, in the next 12 months, that inflation-
adjusted returns on money market investments will favor
those denominated in foreign currencies over those in U.S.
dollars. If global investors need to "park" funds, it would
appear that there are better currencies in the world to do
it in than the dollar. And, if, at the margin, more parking
of funds is done abroad, then the dollar will depreciate,
raising the U.S. inflation rate all the more.
Currently, the spread between the Treasury note maturing on
2/15/11 and the inflation-protected Treasury note maturing
on 1/15/11 is about 1.45 percentage points. These
inflation-protected notes preserve an investor's return
against a rising CPI. With the October CPI year-over-year
change standing at 2.03% and with Governor Bernanke
implying that the Fed would crank up the dollar printing
presses even more than it already is doing if the CPI's
growth should start to weaken, why not buy the inflation-
protected note and short the unprotected one? Isn't the
current spread between the two likely to widen with
inflationistas in control at the Fed?
The rest of the world advances the U.S. about $1.5 billion
a day. Back in the 1990s, when we also were getting
relatively large advances from the rest of the world, we
were using these advances for things that had the prospect
of making our future non-inflationary economic growth rate
higher. If things had worked out, our standard of living
also would have grown faster. This would have enabled us to
pay interest and dividends on these advancements to the
rest of the world - perhaps even pay back a little
principal - without enduring a decline in our standard of
living. Indeed, because global investors thought we were
using their advancements of funds in a way that would
increase the probability of payments to them of principal,
interest, and dividends in "honest "dollars, they were more
than happy to keep investing in America.
But now, we are using a much lower percentage of foreign
advancements for nonresidential fixed investment. Rather,
we are using the $1.5 billion a day from the rest of the
world to buy bigger cars, bigger houses, and cruise
missiles. Bigger cars, bigger houses, and cruise missiles
are not the stuff of productivity growth, and, thus, future
growth in our standard of living. How might we try to
service our foreign debt - debt denominated in U.S. dollars
- without enduring a decline in our standard of living?
Enter Governor Bernanke.
We might put pressure on him to crank up the dollar
printing press. And what will foreign investors, who
already own about 24% of America, do if they begin to sense
they are going to be paid back in "dishonest "dollars?
They will flee from dollar-denominated investments.
Regards,
Paul Kasriel,
for The Daily Reckoning
Editor's note: Paul Kasriel is Senior Vice President and
Chief Economist at Northern Trust Co and a former Fed
officer and university lecturer. Mr. Kasriel is a frequent
contributor Apogee Research and the Daily Reckoning. This
essay was originally published by Apogee Research.
See: Apogee Research
http://www.apogeeresearch.com/dr/
Fed's implicit pledge to crank out as many new dollars as
needed to stave off deflation makes foreign currencies and
inflation-protected Treasury notes all the more attractive.
Paul Kasriel wonders how creditors of the world's largest
net debtor nation might react.
INFLATIONISTAS AT THE HELM
By Paul Kasriel
"World's largest debtor [U.S.] pledges to pay you back in
cheaper dollars." In effect, this is what one of the rookie
members of the Federal Reserve Board, Ben Bernanke,
announced to the world on November 21. He said that the Fed
had the tools, and the talent, to borrow a line from that
cinema classic, "Ghostbusters," to print unlimited supplies
of U.S. dollars. So fear not deflation. The Fed has
implicitly pledged, to its dying breath, that it will crank
up the currency printing presses to prevent it.
Now, I find it remarkable that a representative of the
central bank to the world's largest net debtor nation
would publicly make such a pledge. I don't, however, find
it remarkable that this central bank would privately harbor
such thoughts. After all, isn't a little (or maybe, a lot)
of inflation what debtors want to bail them out of their
financial obligations? Doesn't it imply less of a cut in
your standard of living if you can pay back some
unsuspecting sap in dollars that buy less?
As a nation of net debtors, we want inflation. And this
Fed, unlike the one guided by an "old era" central banker,
William McChesney Martin, aims to please its domestic
constituency. If inflation is what it wants, inflation is
what it will get. (Incidentally, Japan is a net creditor
nation. Creditors, especially those whose credits have
little default risk, generally would opt for falling prices
of goods and services rather than rising prices. Might this
have something to do with the rest of the world being in a
tizzy over Japan's falling CPI, while the Japanese
citizenry is less concerned?)
Currently in the U.S., you can earn about 1&3/8% on three-
month "wholesale" bank deposits. The October reading on the
year-over-year change in the U.S. CPI was 2.0%. So,an
investor is receiving a negative "real" return on this
investment to the tune of 60 basis points. A global
investor could do better by holding comparable paper
denominated in other currencies. For example, at the
beginning of this week, three-month money denominated in
pound sterling was yielding 1.64% after subtracting the
U.K. October inflation rate. That's an inflation-adjusted
pickup of 229 basis points over a three-month U.S.
investment.
Heck, even in Japan, where three-month rates are hovering
just above zero, you can earn a deflation-adjusted return
of 0.76% - a 141 basis-point pickup over dollar-denominated
money. And if Governor Bernanke has anything to say about
this, the odds are, in the next 12 months, that inflation-
adjusted returns on money market investments will favor
those denominated in foreign currencies over those in U.S.
dollars. If global investors need to "park" funds, it would
appear that there are better currencies in the world to do
it in than the dollar. And, if, at the margin, more parking
of funds is done abroad, then the dollar will depreciate,
raising the U.S. inflation rate all the more.
Currently, the spread between the Treasury note maturing on
2/15/11 and the inflation-protected Treasury note maturing
on 1/15/11 is about 1.45 percentage points. These
inflation-protected notes preserve an investor's return
against a rising CPI. With the October CPI year-over-year
change standing at 2.03% and with Governor Bernanke
implying that the Fed would crank up the dollar printing
presses even more than it already is doing if the CPI's
growth should start to weaken, why not buy the inflation-
protected note and short the unprotected one? Isn't the
current spread between the two likely to widen with
inflationistas in control at the Fed?
The rest of the world advances the U.S. about $1.5 billion
a day. Back in the 1990s, when we also were getting
relatively large advances from the rest of the world, we
were using these advances for things that had the prospect
of making our future non-inflationary economic growth rate
higher. If things had worked out, our standard of living
also would have grown faster. This would have enabled us to
pay interest and dividends on these advancements to the
rest of the world - perhaps even pay back a little
principal - without enduring a decline in our standard of
living. Indeed, because global investors thought we were
using their advancements of funds in a way that would
increase the probability of payments to them of principal,
interest, and dividends in "honest "dollars, they were more
than happy to keep investing in America.
But now, we are using a much lower percentage of foreign
advancements for nonresidential fixed investment. Rather,
we are using the $1.5 billion a day from the rest of the
world to buy bigger cars, bigger houses, and cruise
missiles. Bigger cars, bigger houses, and cruise missiles
are not the stuff of productivity growth, and, thus, future
growth in our standard of living. How might we try to
service our foreign debt - debt denominated in U.S. dollars
- without enduring a decline in our standard of living?
Enter Governor Bernanke.
We might put pressure on him to crank up the dollar
printing press. And what will foreign investors, who
already own about 24% of America, do if they begin to sense
they are going to be paid back in "dishonest "dollars?
They will flee from dollar-denominated investments.
Regards,
Paul Kasriel,
for The Daily Reckoning
Editor's note: Paul Kasriel is Senior Vice President and
Chief Economist at Northern Trust Co and a former Fed
officer and university lecturer. Mr. Kasriel is a frequent
contributor Apogee Research and the Daily Reckoning. This
essay was originally published by Apogee Research.
See: Apogee Research
http://www.apogeeresearch.com/dr/