The Fed sinks the Dollar

Published on Counterpunch, by MICHAEL HUDSON, May 1, 2008.

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 …

… 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. (full text).

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