A Rock and a Hard Place

Click on the title of this article to read David Galland's paper from Kitco Casey. I concur with the general view of this article that the US Federal Reserve is facing a difficult choice. On one hand the extended period of uncontrolled monetary expansion has led the US economy into what is now clearly a pre-recessionary period. The credit crunch and housing market collapse are both in their early stages. They are part of a natural market driven corrective process which should appropriately lead the US economy into a recession. This would be at its nature a deflationary correction with widespread falls in asset prices leading to de-monitisation. What Mr. Galland has identified is the second choice the Fed has, and ultimately a far less responsible one. That is, to restart the process of monetary expansion.

There is one key problem with the "inflate to success" approach, namely the US dollar. The US dollar has been under extended selling pressure for sometime and is in the woes of an extended decline.....an extended but orderly decline. The risk with the remonitisation approach is that foreign holders of US dollars finally have enough of the steadily declining value of their investments and pull out of the US currency and treasuries en masse. This was recently described by one Chinese commentator as the "nuclear option". Nuclear is the right descriptive term, and this is pretty much the assumption that the US Fed is working from; namely that the consequences of wholesale dumping of US dollars are mutually unacceptable to both sides of the transaction.

It is unclear at this stage as to whether the consistent falls in the USD could at some stage transpire into a genuine rout.