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The Price-Wage Squeeze

The Fed Sinks the Dollar

by MICHAEL HUDSON

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.

This simplistic philosophy was a hallmark of the Greenspan era. Changing the interest rate alone meant that the Fed didn’t have to “think,” didn’t have to regulate markets, raise reserve requirements on bank loans to fuel the asset-price inflation that the Fed confused with real “wealth creation.” It didn’t have to regulate subprime lending or rain in widespread financial fraud. All it had to do was raise interest rates when this gave banks an opportunity to charge more and increase their earnings – or cut interest rates to lower cost of bank borrowing from the Fed.

But surely not even the ideologically hide-bound Federal Reserve can still imagine that a structural problem – the looming depression from the Fed’s favoritism to the banking sector promoting de-industrialization of the economy – can be solved by lowering interest rates yet again. While the Fed lowers its rate for lending to banks, these banks have not been passing on the rate cuts to their customers. Credit card rates are going up, and entire Christmas trees of penalties are further increasing banks’ rake-off. Mortgage rates remain high, so that real estate markets remain in the doldrums. The banks simply are not lending.

What they are doing is speculating, above all against the dollar. They thus are emulating what Japanese banks did after that nation’s financial bubble burst in 1990. Japan’s banks became the most active players in the international “carry” trade: borrowing at very low interest rates in a weak currency (the yen after 1990, the dollar today) to lend to high-interest borrowers, preferably with strong or at least stable currencies (such as to Iceland before it became so debt-ridden that its currency began to collapse last year; and today, the to European borrowers in euros).

So fiat US credit is being directed to Europe. US banks create or borrow credit at 2%, and lend it out at 6% or more – and get a speculative foreign-currency gain as the euro continues to rise against the dollar.

The aim evidently the same as it was in Japan after 1990. Many banks are nearly insolvent as a result of the b ad real estate loans on their balance sheets. To rescue them (so that it is not necessary to nationalize them, as England recently had to do with Northern Trust) is to help banks “earn their way out of debt” – by making profitable loans.

But bank lending and profitability has become decoupled from the economy at large. Banks are not lending to finance tangible capital investment and new hiring. Helping them thus does not help pull the US economy out of the deepening depression. (A recession is short and is followed by recovery. Today’s looming economic depression is headed toward a widespread forfeiture and transfer of property from debtors to creditors.)

The ultimate effect is to inflate the power of finance, credit and real estate relative to labor’s wages and industrial capital. This is not a way to encourage new tangible investment. It is just the opposite of Keynesianism. Rather than signaling “euthanasia of the rentier,” it is empowering finance and applying euthanasia to labor and industry.

And to Europe, I should add. The Fed’s act to subsidize U.S. bank lending to Europe will help raise the euro’s exchange rate relative to the dollar. This will be a boon to currency speculators. And it will help keep the price of oil and food down to European consumers. But it also will raise the price of European labor and other domestic costs (including the cost of real estate, which is playing a rising role in employee budgets throughout the world). This will tend to make European exports even more expensive in global markets – including the Airbus, much to the joy of Boeing, and European autos, much to the joy of GM and Ford. (No wonder Kirk Kirkorian recently began buying back into the U.S. auto industry.)

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.

MICHAEL HUDSON is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com