While I cringe to find myself on the same side of the fence as Sarah Palin, she and Republican politicians in Washington D.C. may be right to fear Ben Bernanke and the Federal Reserve’s new effort of quantitative easing. The Federal Reserve’s proposed plan is to buy $600 billion in Treasury bonds by June 2011. Their aim is to lower long-term interest rates and to keep the dollar cheap, thereby stimulating the U.S. economy by encouraging the sale of goods overseas. While Palin may not understand why she objects the plan, I do: it has the potential to antagonize U.S. trade partners and stiffen foreign trade.
Dissenting Conservatives are concerned with the long-term effects of the move, which could cause a domino effect of runaway inflation and frustrate U.S. trade partners. Bill Gross, the manager of the largest mutual fund in the world, Pacific Investment Management Company, LLC (PIMCO), questioned the move last month. He believes the Federal Reserve’s effort of pumping 900 billion dollars into the system could result in a decline in the U.S. dollar of up to 20 percent. The Fed argues that a decline in the value of the dollar is exactly what the U.S. economy needs to stimulate the sale of goods overseas. However, will nations around the globe want to continue interacting with the U.S. if we threaten the price of their goods?
This move will frustrate U.S. trade partners, like China. At the beginning of November, the official Xinhua news agency cast doubt on the bond-buying enterprise, calling it a “self-centered” move that will have “considerable spill-over effects in the other parts of the world.” Additionally, according to Barry Eichengreen, a professor of economics at University of California, Berkeley, and Douglas Irwin, a professor economics at Dartmouth College, quantitative easing will reflate the Chinese economy. This could frustrate China because inflation there is already alarmingly high.
There are already signs that China’s frustration with quantitative easing has caused them to move away from the U.S. dollar. According to The Market Oracle, in September China supported a Russian proposal to begin trading using the yan and the ruble rather than the U.S. dollar. Additionally, it sought to make an agreement with Turkish Prime Minister Erdogan to exclude the U.S. dollar and instead use their own currency in their planned trade of $50 billion over the next five years. According to Gross, investors are withdrawing from the U.S. dollar because quantitative easing lowers the yield investors earn on the dollar. Therefore, the already fragile dollar could suffer a blow in the foreign market if quantitative easing is enforced.
The easiest way to frustrate a financial giant is to enforce hypocritical financial reform. For the last several years, the U.S. has fronted an attack on China for devaluing its currency, insisting that U.S. businesses cannot compete with China’s low prices. The U.S. House of Representatives recently passed a bill attacking China’s management of its currency and in late October, U.S. Treasury Secretary Timothy Geithner fostered an international agreement that would discourage currency devaluation among the G-20 nations. If the U.S. violates this agreement by devaluing its currency, it may anger China and the G-20 nations and jeopardize foreign trade relations.
The most daunting aspect of the plan is that it has already failed before. In November 2008, the Federal Reserve implemented a $600 billion quantitative easing program. Four months later, the plan was not performing, so the Fed upped the total to $1.8 trillion. It will be difficult for the Fed to argue the plan worked, since the unemployment level is shockingly high, 9.3 percent, businesses are in the red, and the housing market is floundering. When the plan was implemented in November, 2008, unemployment was at 6.5 percent, and a year later it rose to 9.4 percent. While there are surely other factors that contributed to the rise, it is evident that quantitative easing did not resolve unemployment. Why is the Fed reinstating a formerly botched plan and estimating a different result?