Intervention will not stop dollar's slide
By Peter Schiff
The US Federal Reserve last week took a step closer to acknowledging reality.
Unfortunately, it didn't let that admission move it from a policy course firmly
guided by fantasy.
In its policy statement, Fed chairman Ben Bernanke & Co took the important
step in noting that inflation expectations had taken hold in the country at
large. However, in asserting that it expects inflation to moderate this year
and next, the Fed gave no indications that these heightened expectations are
gaining traction within the rate-setting Federal Open market Committee itself.
As a result, it signaled no likelihood that it was actually prepared
to do something to fight a problem it doesn't really believe exists in the
In fact, by indicating that it expects inflation to moderate, the Fed is saying
that elevated expectations are unwarranted. In other words, Bernanke claims
that despite the fact that so many people are carry umbrellas, he still
believes it will be a sunny day. The takeaway from the statement is that no
rate hike is forthcoming.
The markets saw this position for what it is ... capitulation to inflation and
a weakening dollar. No surprise then that the gold responded with the biggest
single day gain in more than 20 years!
With the ensuing carnage on Wall Street, many Thursday-morning quarterbacks
claimed the Fed missed an opportunity to reverse the dollar's slide by either
talking tougher or perhaps actually raising rates a quarter point. If the Fed
really believed it could talk the dollar up, or that a small rate hike would do
the trick, it would have given it a try. I believe it chose a dovish route
because of a greater fear of having their hawkish stance casually disregarded.
Imagine what would happen if the Fed raised rates and the dollar kept falling?
It would be like one of those horror movies where someone holds a cross up to a
vampire, and the Count tosses it aside with nary a cringe.
Others claim that now is the time for coordinated central bank intervention to
reverse the dollar's decline. Those who place their faith in such a plan
overlook the fact that Asian and Middle East central banks have been
unsuccessfully intervening on the dollar's behalf for years.
Those nations maintaining dollar pegs must constantly intervene in the foreign
exchange markets by buying dollars to keep their own currencies from rising in
value. Over the past few years, the scope of this intervention has been
unprecedented, with foreign central banks accumulating trillions of excess
dollar reserves. Yet despite these Herculean and misguided efforts, the dollar
has fallen drastically.
Intervention advocates must believe that if the European Central Bank (ECB) and
a few other central banks joined the fray, that a better outcome would be
achieved. However any additional efforts to artificially prop up the ailing
dollar will be equally ineffective.
Even if ECB intervention could slow the dollar's decent, what possible reason
would they have for doing so? The ECB is already concerned about inflation and
is preparing to raise rates as a result. Intervention to support the dollar
will only worsen Europe�s inflation problem and run counter to these
efforts. This is because to buy dollars the ECB must increase its own money
supply. That is exactly what is happening in countries like China and Saudi
Arabia, which is why inflation in those nations is already much higher than it
is in Europe.
Further, since the ECB is asking Europeans to endure higher interest rates to
fight their inflation battle, why should they have to make additional
sacrifices to help Americans fight their own inflation? Especially when our own
central bank has held interest rates at the ridiculously low level of 2%, and
has effectively excused Americans from the conflict.
Since we can't count on any help from our friends, the only option would be for
the Treasury to intervene unilaterally. However, the US government should think
twice about bringing a knife to a gunfight. The Treasury has only about US$75
billion in foreign currency reserves with which to intervene. The war chest is
just a spit in the ocean.
To put this number in perspective, Poland has $77 billion, Turkey has $78
billion, and Libya has $79 billion. On the other end of the spectrum, China has
$1.7 trillion (not counting Honk Kong�s $150 billion) Japan has $1
trillion, Russia has $550 billion, India and Taiwan each have about $300
billion. Singapore, a nation with fewer than five million people, has $175
In fact, the United States holds just about 1% of the world's $7.6 trillion of
foreign currency reserves, and our total position amounts to just 2.5% of the
total daily volume of foreign exchange trading.
Talk about Bambi versus Godzilla! In other words, if the dollar is going to
fall, the Treasury is completely powerless to do anything to stop it.
Peter Schiff is president and chief global strategist of Euro Pacific
Capital. He is the author of Crash Proof: How to Profit from the Coming
Economic Collapse (Wiley & Sons, 2007) and his second book is scheduled for
publication in early 2009. Euro Pacific Capital commentary and market news is
available at http://www.europac.net. It has a free on-line investment