Questions I Have From Currency Wars

Last week I finished listening to the audio book version of Currency Wars: The Making of the Next Global Crisis. The part of the book talking about the financial war game he participated in was entertaining. His discussions of the history of the Federal Reserve and currency wars was both very dry and important. I could not help but try to apply some of his ideas to today’s events. Here are some of my questions.

  1. If the Federal Reserve is concerned with US economic weakness then why did the Federal Reserve allow the dollar to appreciate so much compared to the Euro? When you look at the drop in the price of oil and the appreciation of the Euro, it is not hard to see weak US earnings. The latest GDPNow forecast from the Atlanta Federal Reserve is forecasting a GDP growth of less than 1% for the first quarter. So why is the Federal Reserve talking about raising interest rates when this would likely slow the economy even more and increase unemployment?
  2. The second question is how does the Federal Reserve unload its mortgage bond and long-term Treasury notes portfolio and not go broke? I understand why it makes sense for the Federal Reserve as the lender of last resort to not mark their securities to the market price since they have the financial wherewithal to hold the securities to maturation. The Federal Reserve can publicly ignore the mark-to-market value of their portfolio but at some point somebody inside the Federal Reserve is going to have a panic attack that the size of the long term bond portfolio is impacting the Fed’s ability to manage the financial markets with talk. Eventually the Fed will have to back up its talk by acting more like a bank and rebuilding its capital or risk expediting the decline of the dollar as the world’s reserve currency. The recent enthusiasm for the Asian Infrastructure Investment Bank (AIIB) among American allies not just in Asia but in Europe has to be worrisome for the Fed. Mr. Rickards framed this problem nicely in a recent article on the Daily Reckoning, “6 Major Flaws in the Fed’s Economic Model“.

    5) The Fed is now insolvent. By buying highly volatile long-term Treasury notes instead of safe short-term treasury bills, the Fed has wiped out its capital on a mark-to-market basis. Of course, the Fed carries these notes on its balance sheet “at cost” and does not mark to market, but if they did they would be broke. This fact will be more difficult to hide as interest rates are allowed to rise. The insolvency of the Fed will become a major political issue in the years ahead and may necessitate a financial bail-out of the Fed by taxpayers. Yellen is a leading advocate of the policies that have resulted in the Fed’s insolvency.