Those Missed Opportunities…

With the ensuing carnage on Wall Street, many Thursday-morning quarterbacks claimed the Fed missed an opportunity to reverse the dollar’s slide by either talking tougher or perhaps actually raising rates by a quarter percentage point. If the Fed really believed it could “jawbone” the dollar higher, or that a small rate hike would do the trick, policymakers would have given it a try.  I believe they chose a dovish route because of a greater fear of having a hawkish stance casually disregarded.   Imagine what would happen if the Fed raised rates and the dollar kept falling?  It would be like one of those horror movies where someone holds a crucifix up before an advancing vampire, only to have the Count sweep it aside without so much as a cringe.

Some observers claim that now is the time for a coordinated central bank intervention to reverse the dollar’s decline.  Those who place their faith in such a plan overlook the fact that Asian and Middle East central banks have been unsuccessfully intervening on the dollar’s behalf for years.  Nations that maintain dollar pegs must constantly intervene in the foreign exchange markets by buying dollars to keep their own currencies from rising in value.  Over the past few years the scope of this intervention has been unprecedented, with foreign central banks accumulating trillions of excess dollar reserves.  Yet despite these misguided, Herculean efforts, the dollar has fallen drastically.

Help From Across the Pond?

Intervention advocates must believe that if the European Central Bank (ECB) and a few other central banks joined the fray, that a better outcome would be achieved.  However, any additional efforts to artificially prop up the ailing dollar will be equally ineffective.

Even if ECB intervention could slow the dollar’s descent, what possible reason would the Fed’s European counterpart have for doing so?  The ECB is already concerned about inflation and is preparing to raise rates as a result.  Intervention to support the dollar would only worsen Europe’s inflation problem and run counter to these efforts. To buy dollars, the ECB must increase its own money supply.  That is exactly what is happening in countries like China and Saudi Arabia, which is why inflation in those nations is already much higher than it is in Europe.

Further, since the ECB is asking Europeans to endure higher interest rates to fight inflation in their own backyard, why should Europe’s citizens have to make additional sacrifices to help Americans fight inflation in the U.S.