Wednesday, December 12, 2007

Blaming inflation on the foreigners

Here is the Washington Post trying to explain that the Federal Reserve no longer control prices and that the 4 percent inflation rate is all the fault of the foreigners.

The conclusion is obvious; since the foreigners cause the inflation then it is OK for the Fed to cut interest rates.

Inflation Echoes From Abroad

The Federal Reserve disappointed Wall Street yesterday with its measly quarter-point reduction in interest rates. Yes, the Fed said, credit conditions have deteriorated and a recession is possible, but with consumer prices likely to end the year up nearly 4 percent, we're not exactly in the target zone for price stability, either.

As it happens, there's probably little the Fed can do about inflation right now. That's because the sources of inflationary pressures are global rather than national, and thus not very responsive to the Fed's anti-inflation medicine. To understand how this happened, stay with me for a short, explanatory detour into international economics.

It's always been said that when another country ties its currency to the U.S. dollar, it is effectively giving up the right to control its own monetary policy and handing it to the Fed. Over the years, a number of countries have learned this lesson -- painfully -- as they found themselves unable to tame inflation, respond to a recession or stop a run on their currencies.

What we are discovering, however, is that if enough countries go this route and adopt some form of dollar peg, it's not only the other countries that lose control of monetary policy -- to a degree, it's the United States as well.

As you probably have figured out, the big culprit here is China, whose insistence on preventing its currency from appreciating against the dollar has created huge imbalances in the global economy. But it's not just China. A number of other of Asia's export tigers also use various mechanisms to keep their currencies roughly pegged to the dollar, as have many Middle Eastern countries whose economies are tied to oil that is priced in dollars. There are also countries in Central and South America that are careful not to let their currencies wander too far from that of their largest trading partner. Add it all up and you're talking about more than 40 percent of the global economy that is dollar-pegged to some degree.