It’s obvious by now that the European Central Bank and its President Mario Draghi are following a diametrically opposite monetary policy than the American central bank, the famous FeD. Both Draghi and ECB Vice President Vítor Constâncio have loudly reassured everybody that the Eurozone’s central bank will continue injecting €60 to €80 billion a month into the economy. And they stress that this is to continue for as long as it sees it necessary, while keeping the basic interest rates close to zero.
At the same time the American Fed is contemplating to start getting back some of the $4.5 trillion of cash it had injected into the US economy from January 2008 until November 2015. Fed’s head Janet Yellen and her policy making council colleagues have also said that the basic dollar interest rates will continue increasing all along this year. The US central bankers also agree that the American economy is in a strong and sustainable growth path. That’s why the Fed is compelled to gradually retrieve some of the trillions it has printed in order to counter the devastating effects of the 2008 financial meltdown. To let all that money on the loose in a strong growth period may trigger a devastating hyperinflation. So the Fed is obliged to follow an overall restrictive monetary policy that is higher interest rates and cutting down on quantitative easing. There is more to all that though.
Diverging monetary policies
For one thing, this striking divergence of monetary policy in the two shores of the North Atlantic Ocean is to keep at the present low levels or further suppress the exchange rate of the euro in relation to the dollar. Currently, this rate oscillates around 1.06 but some analysts predict full parity within the year. This is to happen if the Fed does embark on a full scale restrictive policy.
Apart from increasing its interest rates, the Fed now readies to start calling back the money it has injected into the economy. This can be realized by stopping to reinvest the cash from maturing securities, the ones it has purchased during the past ten years, that is, since the first clouds appeared in the Atlantic skies during the summer of 2007. The first to feel the pressures will be the New York banks.
A portfolio of $4.5 trillion
To be reminded, the American central bank reacted forcefully with the first signs of the last financial crisis. It ejected trillions of dollars into the American economy, through purchases of securities. It still holds $4.5 trillion of such paper and the banks keep the cash. Since a few months ago, the Fed has started increasing its interest rates. It remains though to be clarified when it will also start reducing its ‘investments’ in American securities, thus reducing the $4.5 trillion cushion it has injected into the US systemic lenders.
In this way, rather sooner than later the two most important central banks of the world would be in completely opposing directions policy wise. This means the euro is to become even more cheap than the dollar, thus backing the EU exports to the US and at the same time penalizing the opposite trade flows. However, the Trump administration is complaining about the US trade deficit with the Eurozone, even at the current exchange rates between the two moneys.
Trump has openly accused the Eurozone in general and Germany in particular of exchange rate manipulation aiming at supporting exports. Obviously then, the White House must be now alarmed seeing the American central bank, the Fed, following a monetary policy which is expected to further strengthen the dollar vis-a-vis the euro, and consequently offer more advantages to European exports and penalize the American sales to the EU.
Trump’s unruly reaction
In view of that, the Trump administration has introduced legislation to undermine the independence of the Fed and subject its key policy decisions to the Congress. In this way, the White House hopes to put a stop to the Fed’s restrictive monetary plan, which strengthens the dollar and creates more disincentives for the American exports. Of course, at the same time, the Trump administration, being stuffed with ex New York bankers, opposes the restrictive monetary policy for one more reason. The US lenders will lose the abundant low cost refinancing from the Fed. As a result, the White House has started a dangerous campaign to subject the independent Fed under political control.
Understandably then, the Fed’s Chair Janet Yellen is strongly protesting the curbing of the central bank’s independence. According to Reuters, Yellen, speaking this week at the University of Michigan, said that the independence of the central bank is “very important and results in better decision-making that’s focused on the long-term needs and health of the economy”. The new legislation under deliberation in the Congress demands that the central bank follows a clear rule in setting interests rates and is obliged to justify any changes or divergence from that rule. If this legislation is voted and signed by the President, the independence of the central bank will be fully compromised.
Compromising the Fed
In short, Trump is planning to do exactly what he accused Eurozone and Germany of doing; employing exchange rate manipulation. At the same time, his team of economic advisors and his Treasury Secretary Steven Mnunchin seem not to bother, if their efforts to prolong the expansive monetary policy may lead the US economy to hyperinflation. In conclusion, the Trump administration is indifferent, if their short term political needs gravely endanger the future of the economy.
They want to be seen now as dealing with the Europeans, no matter if such a policy may retaliate badly in the future. At the same time, they also long to keep supporting the Wall Street bankers to continue making billions on free and abundant money from the Fed, at the expenses of the real economy.