How will the Fed get off its Tiger?

By J Saft
December 19, 2008

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

The Federal Reserve and U.S. economy have two considerable risks now that quantitative easing is at hand: keeping the dollar from a disorderly decline and figuring out how to dismount from the tiger.

The Fed has cut interest rates to a range of zero to 0.25 percent and said it would use “all available tools” to get the economy growing again, including buying mortgage debt as well as exploring direct purchases of Treasuries.

While the central bank was at pains to distance its policy from Japan’s during its extended downturn, there can be no doubt that the dollar printing presses are and have been running and will pump out as much currency as is needed to avoid deflation and make credit available at a stimulative rate.

There is no question of the Fed not being able to re-ignite inflation in the U.S. economy; if they print money fast enough, prices will go up. The issue is more about the collateral damage possible when a major debtor nation takes these steps, even if it is doing it for all the right reasons in support of the best possible cause.

In the short term the risk is that foreign holders of the dollar and Treasuries are spooked by the whirring of the presses, and, reasoning that the Fed cannot fail in its quest to re-ignite inflation, decide to hold something less, well, risky.

Now of course in the current circumstances there may, for better or worse, not be that much of a dollar alternative for global reserve managers and investors and, seeing as how a rapid unwind in the dollar would hurt creditors, they may stick it out.

But the risk is higher now than last week, and much higher than earlier this year.

The value of a dollar against a trade-weighted basket of currencies fell sharply after the Fed’s announcement and is down about 10 percent in the past month.

Two factors that had been supporting the dollar through the recent months of the crisis, a tendency by U.S. investors to repatriate dollars during periods of stress and the need to purchase dollars as part of the process of unwinding leveraged financial trades, will not continue forever.

“The risks for the dollar are pretty clear,” said Michael Hart, a foreign exchange strategist at Citigroup in London. “It is going one way and the only question is how uni-directional it is going to be and how many starts and stops we are going to see.”


U.S. policy appears to be aimed at helping to recapitalize the banks and cutting the cost of finance to consumers by buying up assets and is distinct from that of the Bank of Japan, which increased bank reserves.

There are some key differences between the U.S. and Japan, which didn’t have the same need to attract external finance, and for that matter between the U.S. now and the U.S. during the Great Depression. When the Depression struck, the U.S. was the world’s biggest creditor, rather than its principle debtor.

The U.S. economy is both distended and hollowed out; it needs to redirect itself more toward savings and producing goods and services that can be sold overseas. The problem is that doing that quickly will be both very painful and produce a lot of collateral damage. Fed policy can only succeed if it softens the very terrible impact of that reallocation but does not prevent it.

But what happens if, or rather once, the Fed and the U.S. government’s combined stimulus succeeds? How exactly do you unwind a program of Treasury and mortgage asset purchases and near zero rates without bringing on too much inflation, perhaps much too much?

If foreign holders of the dollar stick with it during the next crucial months, there is little to prevent them from bailing out later, if they judge the Fed to have kicked the ball too far down field. There is no way of knowing how this can be undone or what to expect.

There is also another set of actors who can cause problems; foreign central banks and their government bosses. If the dollar weakens much during a time of global recession many will have a hard time resisting the urge to devalue their own currencies in order to capture a bigger share of what little demand remains.

The plan to buy assets to cut the knot of finance is sound but begs the question of how and when the banking system will be brought back to life. I’m not sure that buying time and hoping it can outlive its debts will work.

The new administration needs to, quickly, enunciate a clear and comprehensive policy on how recapitalizations will work, so that private capital and taxpayers can know where they stand.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Raj writes:

“Im facinated by the discussion linking violence with poverty. I grew up in India in the 70’s when the economy and currency management was an absolute mess.”

My question is:

Is the particular region to refer accustomed to abject poverty?

Let me assure you that the majority of America is not.

You continue:

“If you actually need guns then move somewhere safer in Asia rather than live in extreme violence – thats my plan B.”

There are here in North America (I know it’s hard for foreigners to imagine) those who consider these lands to be theirs. They do not just up and go when the going gets tough. I always felt that focusing the base of a nation upon those who flee for comfort was a weak policy of statecraft but nonetheless Americans, historically are not prone to running away from their native soil when things go sideways.

While those ‘guests’ of the continent are more than free to seek refuge elsewhere, those who consider this their home will not.

Posted by Mr. North American | Report as abusive

It forever amazes me how economists are unaware of the political consequences of this or that policy. Do they really expect that government will actually confiscate gold? From burying it in a mason jar in the back-yard to a foreign bank vault! Let the hide-and-and-go seek games begin! From gold teeth crowns to Aunta Agatha’s wedding ring, from Krugerrands to American Gold Eagles (sold by the US Mint) the price per ounce would rise to thousands of dollars overnight. Meanwhile, the peasants will not crawl off in a corner and die quietly. That sound you hear outside the gates of Dr.Frankenstein’s castle is growing louder. The peasants are angry and are carrying torches and pitchforks! Plutocrats have nowhere to run, nowhere to hide. As of now the dolar blizzard is up to our knees. By next year it will be up to our necks. Lay in a supply of gold sovereigns,good cigars and fine whiskey. It is going to be a long, long winter.

Many good points made in the article and comments. Never dawned on me that in our brave new e-world there are many “virtual dollars” not accounted for in the M1! Would advise all that there are skills to be learned beyond the mentioned cigar smoking and whiskey drinking. Purchasing a rural property provides the opportunity to tend a veggie garden and can the output for winter, home grown grass fed beef is cheaper and better for you, too. Reduce, reuse and recycle makes economic and environmental sense. As agricultural and domestic skilled trades will be needed in tough times it will become more useful to be a “maker” than a “consumer”.

Posted by pumpkin | Report as abusive

Actually if you pump money into companies to create products for non-existent markets the end result is not inflationary? Obviously the writer must live in an alternate universe. When you pump money into factories producing things people don’t want – like electric cars it means that the factory is not producing the cars that people do want. Scarcity of the desired product combined with the debt incurred and a loss of capital investment in the goods and services people do want creates stagflation. The cost of goods and services skyrocket as money is flushed down a rat hole.

Posted by Peter Berg | Report as abusive

If your really that scared, go buy land(the only “real” asset), bring a sack lunch and wait for the end of the world.