Fed Exit Strategies And Greek Tragedies

While Bernanke provided more detail on the exit process, he also made clear that he does not expect to tighten policy in any meaningful way anytime soon. He repeated the FOMC mantra that the economy needs “exceptionally low level of the federal funds rate for an extended period.” He set out the Fed’s current thinking on how policy will eventually be tightened, “at the appropriate time …” None of this will happen soon, though, and the likely near-term hike in the discount rate, he was careful to note, “should not be interpreted” as a policy signal.

The bottom line is that the Fed will not materially tighten policy in 2010. More than likely, the funds rate target will be unchanged at year end, there will be no hike in interest paid on reserves and the Fed will have a balance sheet that will still be north of $2 trillion.

Aside from considerations relating to inflation and unemployment, there’s another reason for the Fed to keep borrowing costs as low as possible. I offer the following analysis written by Kelly Evans in The Wall Street Journal. She writes:

The Commerce Department reported Wednesday that the U.S. trade deficit widened in December to $40.2 billion, compared with $36.4 billion in November.

The widening reflects faster growth in imports than exports at year-end, an unwelcome side effect of the U.S. economic recovery. It also is a reminder that export-led growth, which nations are pursuing as a path out of recession, is easier said than done.

President Obama has called for a doubling of U.S. exports over the next five years to help narrow the trade deficit and spur economic growth. The quickest way of doing so is a weaker dollar, which makes U.S. goods and services cheaper in the global market.

But lately, the dollar is moving in the other direction. Worries over the fiscal health of Greece and other nations have dogged the rival euro currency, which hit an eight-month low on Tuesday before closing a few cents higher.

Goldman Sachs economist Sven Jari Stehn calculates that even with above-consensus global growth of 4.5% over the next five years, the dollar still would need to depreciate in inflation-adjusted terms by about 30% for U.S. exports to double to about $3.1 trillion.

If instead the strengthening continues, “it would wipe out all the other bits and pieces [the president] is putting together to encourage exports,” said Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management.

And while investors focus on whether the big European nations will come to their smaller neighbors’ rescue, Mr. Johnson points out that Germany, the world’s biggest exporter until China surpassed it last year, is reaping the benefits to its own exports that come from a weaker currency.

European nations mightn’t be in as much of a hurry as investors assume to halt their currency’s downward slide. That could make an export-led U.S. recovery its own Greek myth.

To that, I would like to add that it seems as if what’s happening now is always what happens in times when the global economy slows-countries pursue a “beggar thy neighbor” policy of currency depreciation in order to boost their exports. Implicit in Mr. Obama’s stated goal of increasing exports is exactly that; a weaker dollar.