At the moment, the Federal Reserve is increasing the money supply in order to increase the U.S. inflation rate from about 1% to about 2% while keeping short-term interest rates close to zero in nominal terms. This action is intended to drive real American short-term interest rates further into negative territory so that Americans spend their money (instead of saving it) and so that the dollar weakens (when private savers sell their dollars in order to earn higher interest rates elsewhere).
But Treasury Secretary Geithner just took the upside out of the Federal Reserve's plan, the weakening of the dollar. As a result, the inflation that the Federal Reserve is producing will increase American imports by increasing American demand for imports, and discourage American exports because the inflation will increase American producer costs. As a result of Geithner's action, Bernanke's plan will make the U.S. economic situation worse, not better.
Specifically, Geithner endorsed the Japanese Central Bank's recent decision to buy dollars and the upcoming decision by the European Central Bank to buy dollars. Here is a what Geithner told the Wall Street Journal:
On currencies, Mr. Geithner said, "We would like countries to move toward a set of norms on exchange-rate policy."...
Mr. Geithner divided world currencies into three groups....
In the third group, he put "the major currencies, which are roughly in alignment now," a suggestion that he sees no need for the dollar to sink more than it already has against the euro and yen. Mr. Geithner emphasized that the U.S. is not pursuing a deliberate policy of devaluing the dollar. Earlier this week, speaking in Palo Alto, Calif., he said that no country can "devalue its way to prosperity and competitiveness."
As a result of Geithner's action, Bernanke's inflationary policy will cause America's huge trade deficits to grow, instead of shrink. The United States will continue to experience the persistent depression caused by persistent trade deficits.
My father, son and I would solve the trade deficits by implementing a scaled tariff. Ralph Gomory would implement import certificates. But most economists would oppose any artificial action to balance trade, because in their ivory towers (but not the real world) floating exchange rates balance trade.
Disclosure: I own Chinese yuan through CYB
