Should the Fed worry about dollar debts?

Here is the Financial Times:

The US Federal Reserve is often buffeted by fierce cross-currents but investors caution that balancing the strong domestic economy and rising turbulence in emerging markets — and now Europe — will require a particularly adept hand at the tiller this year.

Although Argentina and Turkey have been the focus for their own idiosyncratic reasons, Urjit Patel, India’s central bank governor, argued that emerging markets are suffering a broader bout of “upheaval” caused by the “double whammy” of the Fed’s balance sheet shrinkage and the US Treasury’s borrowing binge.

“Given the rapid rise in the size of the US deficit, the Fed must respond by slowing plans to shrink its balance sheet,” Mr Patel wrote in the FT on Monday. “If it does not, Treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.”

Borrowers in emerging markets need to understand that interest rates are volatile.  If they cannot afford to repay dollar-denominated debts when the dollar is strong, then they shouldn’t be borrowing dollars in the first place.  Borrow in your local currency.

Worries about an EM debt crisis are not a good reason to refrain from raising the target interest rate.  On the other hand, the following is not a good reason to raise interest rates:

Indeed, given the robust US economic outlook, some analysts even caution that it runs the risk of overheating. The 10-year “breakeven” rate, a market measure of investors’ inflation expectations, remains above the Fed’s target 2 per cent at 2.07 per cent, despite recent declines, and inflation is expected to continue to accelerate into the summer.

Arrgggh!  I can’t believe that in 2018, respectable publications are still making this basic error.  The Fed does not target the TIPS spread at 2%, as that spread is based on CPI inflation, not the PCE inflation rate that is the actual target of Fed policy.  When CPI inflation is running at 2.07%, PCE inflation runs around 1.8%.


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13 Responses to “Should the Fed worry about dollar debts?”

  1. Gravatar of Ben Ben
    5. June 2018 at 14:17

    BE also includes a risk premium. Should run a good bit above target even if it were based on the correct index.

  2. Gravatar of TheMoneyIllusion » Should the Fed worry about dollar debts? – Courtier en Bourse TheMoneyIllusion » Should the Fed worry about dollar debts? – Courtier en Bourse
    5. June 2018 at 14:30

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  3. Gravatar of Benjamin Cole Benjamin Cole
    5. June 2018 at 16:15

    Interesting post.

    There is a lot of concern in the Far East that Fed tightening and US borrowing will lead to capital flows to the West and the US, thus provoking credit tightness and then a property price plummet in Asia.

    This real estate dump could spread to the US. We know what happens when real estate values fall in the US; you get a financial system collapse.

    About one-half of US commercial banks loans are extended on real estate, and banks borrow short to lend long. Inherently vulnerable.

    OT, Sumner has a post on Kevin Erdmann and housing prices in his latest Econlog missive.

    It is worth pondering why 1000 US macroeconomists will sign a fear-mongering letter that Trump’s trade policies will likely trigger another global Great Depression, but Erdmann soldiers on nearly alone on the issue of property zoning.

    Kudos to Sumner and the Mercatus Center for shedding some light on Erdmann, and the larger and more-dangerous structural impediment of property zoning.

  4. Gravatar of doug M doug M
    5. June 2018 at 16:55

    TIPS spread at 2.08 does show that that “the market” is showing a fair amount of confidence that the Fed will indeed hit its targets.

  5. Gravatar of ssumner ssumner
    5. June 2018 at 17:34

    Ben, You said:

    “It is worth pondering why 1000 US macroeconomists will sign a fear-mongering letter that Trump’s trade policies will likely trigger another global Great Depression”

    I’d love to see that letter, but I doubt it exists.

  6. Gravatar of Benjamin Cole Benjamin Cole
    5. June 2018 at 19:19

    More than 1,000 economists warn Trump his trade views echo 1930s …
    https://www.theguardian.com/…/donald-trump-trade-economists-warning-great-depres…

    May 3, 2018 – Over a thousand economists have written to Donald Trump warning … The 1,140 economists, including 14 Nobel prize winners, sent the letter …

    Economists Invoke Great Depression in Warning to Trump on Trade …
    https://www.bloomberg.com/…/economists-invoke-great-depression-in-warning-to-tru…

    May 2, 2018 – Economists Invoke Great Depression in Warning to Trump on Trade. By … Many of its passages quote directly from another letter sent in 1930, …

  7. Gravatar of Benjamin Cole Benjamin Cole
    5. June 2018 at 19:28

    Politics—Bloomberg

    Economists Invoke Great Depression in Warning to Trump on Trade
    By Josh Wingrove

    May 2, 2018, 3:00 PM GMT+7
    U.S. ‘paid the price’ for tariffs in 1930, letter says
    Signatories caution against repeating protectionist history

    To some of the biggest voices in U.S. economics, it could be 1930 all over again.

    More than 1,100 economists, including Nobel laureates and former presidential advisers, have signed a letter warning Donald Trump about his tariff-heavy approach to trade. Many of its passages quote directly from another letter sent in 1930, cautioning against protectionist measures the U.S. imposed at the start of what became the Great Depression.

    “Congress did not take economists’ advice in 1930, and Americans across the country paid the price,” the economists say in the letter, due for release Thursday. “Much has changed since 1930 — for example, trade is now significantly more important to our economy — but the fundamental economic principles as explained at the time have not.”

    —30—

    Given Doug Irwin’s findings, and Scott Sumner’s superb book, we know that the Smoot-Hawley’s tariffs had little bite, but that monetary policy drove the US down, along possibly with some NRA stuff.

    I stand by statement that US macroeconomists engage in hyperbole and fear-mongerig when they discuss global trade issues. How is the above statement not fear-mongering?

    It may be that Trump tariffs will slightly lower US living standards, or possibly slow US GDP growth. That is a reasonable argument. The record after Nixon and Reagan tariffs and trade restrictions does not suggest a Great Depression.

    Or, a proponent might say trade tariffs, carefully executed, will raise US GNI while encouraging capital investment in US plant and equipment and will have some long-run payoffs.

    How about we predict “a US economic boom” after Trump tariffs are implemented? That is about as likely as a Great Depression.

  8. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    6. June 2018 at 03:41

    I still worry about Nikkei’s buyout of FT

  9. Gravatar of bill bill
    6. June 2018 at 07:10

    The good thing about a 10 year BE of 2.07% (on CPI) might be that even though the Fed recently said overshooting (ie, procyclical) inflation is OK, the actual policy is less procyclical than feared? My sense though is that with projected NGDP growth at 4.6%, a moderately lower 10 year BE would be more appropriate.

  10. Gravatar of Ignacio Morales Ignacio Morales
    6. June 2018 at 08:13

    This a quote from the people of Bank of America ML: “The strong U.S. dollar has put emerging market (EM) currencies and credit under pressure, but Anne Milne debunks the myth that EM corporate debt levels are too high. Excluding China, the top 16 major EM countries’ average corporate debt is 48% of GDP, 26ppts LOWER than U.S. corporates.”

  11. Gravatar of ssumner ssumner
    6. June 2018 at 08:19

    Ben, So where is the letter that supposedly makes this claim? Your links don’t provide it. Nor do the quotes you provide back up your claim. You should not make assertions unless you can back them up.

    Ignacio, Thanks, that’s interesting.

  12. Gravatar of Alec Fahrin Alec Fahrin
    6. June 2018 at 16:19

    Wasshoi,

    I agree. As a longtime reader of FT, I noticed a perceptible difference in reporting between 2000-2015 FT and after. This is especially so during the recent Abe travails where his partners are being caught redhanded in corruption, and the related popularity plummet/market fall.

    You will not see any pessimistic news about Japan in FT’s commetary/opinion section. But I’ve seen an immense increase in pessimistic/hostile news about Japan’s rivals.
    As expected.

  13. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    7. June 2018 at 04:39

    Alec Fahrin-san, I read your comment. =^-^= =^-^= =^-^=

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