Everyone from the Chinese to Alan Greenspan is slamming the Fed’s new round of longer-term bond purchases (QE2) as a back-door plot to weaken the dollar. The logic is that the bond purchases should lower interest rates, thereby lowering the demand for dollars and causing the dollar’s price to fall, thereby raising U.S. net exports. That much is true, but it leaves one thing out:
That’s exactly how expansionary monetary policy is supposed to work!
It’s even in a lot of macroeconomics principles textbooks: When the Fed lowers interest rates, the lower rates are supposed to raise GDP by spurring household consumption and business investment (that much is in every principles textbook) and secondarily by lowering the demand for U.S. bonds, thus lowering the demand for dollars and weakening the dollar, thus raising U.S. exports and lowering our imports. This effect is sketchier than the effects on consumption and investment, since net exports are very volatile and do not respond quickly to changes in exchange rates, but it is there.
So why exactly is it currency manipulation when it’s part of QE2 (which is only expected to reduce interest rates by about 20 basis points and so far has actually seemed to raise them a bit, due to inflationary expectations and the Fed’s surprise decision to concentrate its purchases on medium- rather than long-term bonds) but not when it’s part of the Fed’s zero-federal-funds-rate policy? I’m thinking the selective outrage might have something to do with President Obama’s meetings with Asian and G-20 leaders this week. The Chinese are happy to grasp at this new straw in order to deflect attention from their more blatant attempts to keep the yuan low, the Europeans are seeking some company for their draconian budget-slashing misery, and Greenspan is bandwagon-jumping as usual.
P.S. Although I think this particular criticism of QE2 is bogus, I am against QE2 for a host of other reasons, which I’ll get to in another post sometime.