Between the Rock and the Hard Place

The once-in-a-generation tectonic shift in the dollar’s value, the global reserve currency, is bound to have unanticipated political and financial consequences we may be powerless to address.

In the name of fighting inflation in America, the Federal Reserve continues to raise interest rates, thereby creating global inflation by attracting foreign capital to the US seeking higher returns, resulting in the recent Euro/Dollar parity, a ~30% drop in the value of the British Pound, and a ~20% drop in the value of the Japanese Yen, not to mention the negative effects of our balance of trade with China as a result of the dollar trading at over seven Yuan.

Talking tough and acting like the second coming of Paul Volcker, Federal Reserve Chairman Jerome Powell has suggested his impetus for raising rates is rooted in the need to tame the recent alarming inflation rate. This attempt is both disingenuous and dangerous because it ignores the fact that it was the Fed itself that created incipient inflation through its loose monetary policy over the past twelve years. The idea that inflation can be tamed in a meaningful way through tiny incremental interest rate rises is misguided as long as nominal rates are lower than the inflation rate.

Thus the rock and the hard place i.e. if rates are not increased substantially, it will do no good. But if we see a significant rise in the nominal interest rates, it will crush the economy for the simple reason that Volcker’s move in the 80s was in the context of a federal debt of less than one trillion dollars (30% of GDP), versus today’s debt level at over thirty times that (i.e. $30 trillion, representing 125% of GDP).

Could it be that America is as capable of starting a global currency war, as Russia is capable of starting a global energy war? In times of war, and in a complex global, political, and financial environment where nobody knows what’s going on, it is wise to proceed cautiously.

— Sina.