2009-03-18marketskeptics.com

If the dollars held by foreigners start coming back, it will make life very difficult for the fed. The fed has started buying toxic mortgage backed securities and will soon be buying treasuries. Faced with the return of dollars from abroad, the fed would faced with choice of either controlling interest rates (keep buying assets) or controlling the money (start selling assets). Politically speaking, the fed will be forced to try to control interests rates, which will allow the base money supply to explode, fueling hyperinflation.

This is an incredibly underappreciated point. The selling of US financial securities has been largely contained, as most of the holding is by central banks and other large-scale institutions not prone to panic. The same cannot be said of the US dollar itself. If it starts to rapidly slide, the fall of the dollar could accelerate and most of the currency could find its way back home, where it would suddenly be a highly inflationary problem for the Fed (then again, maybe the Fed wants that).



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