Billmon wrote a piece about the relationship between the volatility on Wall Street the other day, where $120 billion in value vanished, and the Federal Reserve Board. An absurd oversimplification of his analysis would read something like this:
The Federal Reserve Board's Federal Open Market Committee may be concerned about the Bush administration's attempts to let the US dollar exchange rate further drop. It is possible that the committee in suggesting that it, at some undetermined point in the future, would again raise interest rates (which are currently very, very low), was attempting to calm the Asian central banks at the expense of the domestic market. Why are the Asian central banks so deserving of, and hungry for, the Federal Reserve's whispered sweet nothings, because they hold more than $1 trillion in US dollar reserves (i.e. the US government's debt). And if that much money hit the open market, the US dollar would crash very hard. Why would that happen you may ask? You really should read the article but it essentially comes down to the fact that the very countries that the US is attempting to persuade to weaken their currencies are the same countries that hold most of the US debt. If their currencies were to rise, and the dollar were to fall against their currencies, they would have a strong motivation to get rid of their dollar denominated instruments relatively quickly. And there is not a surplus of other candidates who could buy up such a large quantity of debt instruments. This would make the value of those instruments fall still lower until they reached a price that the market felt was appropriate (read: low). Billmon points out that this is in no way a certainty that will happen, but even the possibility is frightening enough that one would want to keep it in mind so as to avoid it in actuality.
In an election year, one of the lower priorities for an incumbent President who is running for re-election is doing anything that weakens the domestic economy in order to benefit anything that is not directly related to his short-term goal of getting re-elected. The Bush administration is not yet particularly focused on the amount of American debt that the Asian countries, particularly China, are holding. Even if it were not an election year, this would not be easy for any administration to deal with. If what bilmon is talking about is really happening, things could get much more interesting.
My words do no justice to the much more nuanced explanation offered at billmon.
Posted by Alan at 30.01.04 12:41