Many people, including the Fed, believe the key to economic recovery is keeping the interest rates low and a cheap dollar. That’s why the Federal Reserve is buying Treasury bills in an effort to contain rates and enable businesses to get cheap financing.
However, many experts believe lowering interest rates was the key factor in starting the current financial crisis. The idea was good at the time; cheap credit enabled people to purchase more products, afford more expensive houses and fuel the economy. That created the housing bubble. The problem is, that affected the way banks were making money, and banks need to make money! They started the subprime mortgages to charge higher interest and raised fees to compensate for lost profits. See my article, “Mortgage Fiasco and Ninja Crisis”.
Actually, higher interest rates can be a good thing as a long term strategy. If the banks perceive they can start making money again on the bottom line (from offering credit lines to customers) they will start lending money, this time to serious businesses and individuals who can afford paying back. The dollar will rise again, but in reality a cheap dollar is creating a lot of friction with the eurozone countries and Japan, and they are threatening to take action.
Dominique Strauss-Kahn, managing director of the IMF, set out the concerns in the Financial Times earlier this week. “There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery,” he said. With the euro at $1.40 and the yen below 85¥/$, both economic powers have no choice but to intervene if the dollar takes another dip.
Above all, officials say, the current financial crisis has shifted influence from the richest powers toward Asia and Latin America, whose economies have weathered the recession much better than those of the United States, Europe and Japan. “Other countries are no longer willing to buy into the idea that the US knows best on economic policy, while at the same time the emerging markets have become increasingly influential and independent,” said Kenneth S. Rogoff of Harvard, “Like it or not, we simply have to accept it.”
At the same time the US government, to avoid an international trade war, is again delaying a probe into the Chinese currency control strategy. Everybody knows the Chinese have been buying foreign currency for decades, keeping the yuan low to boost their exports and competiveness. It is understandable that they want to keep the current situation to avoid a radical change in the Chinese economy. If the US launches a probe into that policy, it has to take action, and that is what the Chinese government tries to avoid.
We need more unconventional thinking to turn this economy around; and the US no longer can think they can do it alone. For every action of the Federal Reserve there will be a counter action by the ECB and the Bank of Japan, and of course from China. We need coordinated efforts to restore confidence in the market so companies start investing again, and especially hiring again.