Is the Fed out of balance? Are the “oceans of liquidity” they’ve created going to come back to bite us?
To be sure, Fed policy is easy. With the worst financial crisis in 50 years just behind us, it has to be. The popping real-estate bubble led to an insolvency crisis at the banks, and now the Fed is recapitalizing the banks by holding short-term rates close to zero. Hey, it worked for Greenspan in the early ‘90s.
But those zero short-term interest rates are causing trouble in any economy that’s linked to the dollar. Those countries essentially import our monetary policy while their economies chug along. Asian economies with booming markets are stuck. If they let their currencies rise they slow export growth at a time of slack demand; if they keep the peg, they engender a credit-driven bubble. And credit bubbles always end in tears.
And the Chinese are concerned about social tranquility at home. With 40 million more young men than women, civil unrest is never far from leaders’ minds. Appreciating the Yuan tightens Chinese money, slowing growth. It would take real guts to make that call.
But the Fed has made it clear that our monetary policy will be driven by domestic, not global, considerations. Global thinking may be part of the reason it took the Fed four years to tighten policy in ’03 through ’07, contributing to our bubble. Bernanke has told the Chinese that it’s our policy but the peg is their problem.
If the Chinese don’t appreciate, their economy will boom and bust. And the consequences won’t be pretty. Developing markets are all strong right now—you can’t afford to ignore them. The best approach is to maintain your discipline, ride the Dragon, and harvest your gains.
Douglas R. Tengdin, CFA
Chief Investment Officer
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