Federal Reserve Exports Inflation

“In those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability.”– Federal Reserve Vice Chairman, Donald Kohn

Thursday’s sharp stock market drop was primarily due to the market’s delayed reaction to Wednesday’s FOMC statement which demonstrated that the Fed is not concerned about maintaining price stability. Now the Fed is trying to prod emerging market countries that peg their currency to the dollar to decouple from the greenback. Call it reverse global engineering.

In a speech Thursday on "Global Economic Integration and Decoupling", Vice Chairman Kohn indirectly acknowledged that the central bank is exporting inflation to dollar-pegged economies, which in turn is driving up the cost of global commodity prices.

Kohn is saying that if these emerging economies decouple from the dollar, commodity prices will decline, which in turn would ease US inflation so the Fed can continue its accommodative policy of helping out the banks. Kohn continues to deny that US inflation has spread beyond food and energy to  "core" when he states that

...rising inflation has chiefly reflected the surge in energy prices, whereas in developing countries, for which food takes up more of household budgets, rising food costs have been a more important culprit.

That remark was followed by this gem:

The reasons for the trajectory and persistence of increases in prices of food and energy this year, as global growth has moderated, are not entirely clear.

Many countries have pegged their currency to the dollar as a way to help maintain price stability. Continuous reiteration of our  "strong dollar policy" by the Treasury Secretary and the Fed has amounted to nothing more than empty rhetoric. Kohn should be careful what he wishes for and consider the law of unintended consequences. If Saudi Arabia decided to de-peg its currency from the dollar, oil prices would skyrocket to unprecedented levels.

Comments

[EUARTE]

Over and over and over the Federal Reserve shows it has lost control. It knows nothing. It doesn't understand what is happening. The Federal Government is coasting till the next administration. Be afraid.

[icandoitdon]

yes...the fed has lost control and the recent decline in equities confirms this loss of confidence in the fed. it's stunning...the fed pulled out every stop culminating with the bear stearns bail out. (yes it was a bailout...taxpayers assumed the risk of 30 billion of their securities.) the fed shot it's wad and it hasn't worked...it's delayed the pain. from this point forward every fed option has serious downside to it.

my vote? sacrifice that portion of the domestic economy that created the problem by raising rates to defend the dollar. that will at least keep foreign money flowing into treasures and right now it's the only source of capital we have. homeowners who lack equity in their homes will take a bath. housing related stocks and financials will join them. they get what they deserve. let them all recapitalize or go under.

the economy will rise again but not until the underlying problem of a weak currency, low interest rates, excess leverage and increasing commodity prices is solved. raising rates to adequately refect the credit risk (and currency risk to foreign investors) is the only way to solve it.

and by the way...sell deep in the money calls or buy put protection if you want to hold stocks.

what can the people do? fire every $*)&^% incumbent that holds office. or if you have real courage, refuse to pay your taxes. that's the only way you get what you pay for in government.

[nova]

Unfortunately, things will get much worse before becoming better.

Our financial and political institutions are utterly corrupt. Our financial system became a con racket to separate people from their money, creating nothing, and enriching themselves beyond any comprehension.

At the same time, people behave like idiots. Just look at the candidates for the White House millions of American voted for. The both candidates have no ideas about the notions of national interests and how to protect and promote them.

American people became too much addicted to spending money they do not have, and they do not realize that the party is over.

One more thing. US$ will continue its fall because America lately has very few things other people/countries like to buy from America. Clinton and Bush Jr. administrations with great help from the Congress have destroyed the American industrial base.

Politicians and Feds will do nothing before this year election then a hell will break loose.

[snakyjake]

I don't understand how inflation is exported. Can someone please explain in more detail with good examples?

[snakyjake]

Can someone please provide examples and explanations of how inflation is being exported? I need something simple to understand.

[icandoitdon]

jake....

our inflation is exported only to those nations with fixed exchange rates against the u.s. dollar.(e.g. saudi arabia and china). as our currency declines so does theirs...forcing up import prices in those countries as it does in ours. by "exporting" our inflation in this fashion, we risk key nations letting their currencies float....making their goods more expensive in the u.s as our dollar declines.

this is the fly in the ointment for those who argue that a cheap dollar helps us sell goods abroad. it also makes imported goods more expensive at home and when you're a nation that depends on imports...as we do...and foreign nations funding our dollar-denominated debt...as we do...that's a prescription for disaster. imagine the havoc it would wreak on our economy if china told us that they'd fund our debt only if it were denominated in their currency. our dollar would collapse and so would our standard of living.

you can't borrow your way to prosperity and you can't debase your currency to gain prosperity either. that's what those fools in congress and in the department of treasury as well as the spinless federal reserve don't seem to understand.