Nobel laureate economist Robert Mundell says the latest moves to prop up weak Western economies by creating inflation is a “big mistake.”
Instead, the Federal Reserve and European Central Bank should intervene in currency markets to limit movement in the world's single most important exchange rate, the euro-dollar pair, he said in an interview in The Wall Street Journal.
"The Fed is making a big mistake by ignoring movements in the price of the dollar, movements in the price of gold, in favor of inflation-targeting, which is a bad idea,” says Mundell, taking square aim at Fed Chairman Ben Bernanke’s expected decision to ramp up asset buying in order to manufacture inflation.
Bernanke’s unusual plan is the direct result of his own public criticism of Japanese political leaders years ago, when he was an academic and the Asian giant faced similar — although not identical — circumstances.
In a speech last week, the Fed chief made clear he would push for inflation despite having already printed trillions of dollars to no avail. Inflation remains low, perilously low according to some at the Fed, and unemployment is likely to stay stuck close to 10 percent for months to come.
Investors have been bidding down the dollar in expectation of a major new Fed initiative. They should have a clear idea of how much new money at the close of the next Fed rate-setting meeting, Nov. 2 and 3.
The resulting pressure has pushed the dollar lower, although many pundits now expect profit-taking on the trade. Some big exporting nations like Brazil have begun to push back ahead of the announcement, hinting at plans to devalue to protect their own exports.
Some worry a hot “currency war” would result in rapid competitive devaluations around the globe and a new wave of protectionism, ultimately collapsing the global economy into deeper recession or much worse.
Meanwhile, the Bank of England has just announced a new $160 billion stimulus package to help it avoid a looming double dip. While technically still an option here, it seems unlikely that a Republican majority in one or both houses would ever sign off on new stimulus spending.
In fact, many candidates running in the Nov. 2 mid-term elections are literally running against the old stimulus plan and the concurrent bank and corporate bailouts.
Though he doesn’t foresee a currency war, Mundell does feel it's important to have a high-level conference — a renewal of the Bretton Woods accord to set global currency policy decades ago — to explore options for reforming the world monetary system.
He says the rise in currency trading by banks is indicative of sickness in the monetary system.
“These currencies should be fixed, as they were under Bretton Woods or the gold standard,” he says. “All this unnecessary noise, unnecessary uncertainty; it just confuses the ability to evaluate market prices."
"The whole idea of having a free trade area when you have gyrating exchange rates doesn't make sense at all. It just spoils the effect of any kind of free trade agreement."
Mundell doubts it would be possible today to make the dollar the central player in a worldwide monetary system because America's position is not nearly as strong now as it was in the 1950s.
Nonetheless, he’s disappointed by the reluctance of the United States to take into account a big movement in the rest of the world to do something about restoring stability to the international monetary system.
"They ignore it, as if the dollar's exchange rate is a mere domestic matter," he says, pointing out that the current U.S.-China dispute over currency valuation is in fact connected to the international role of the dollar.
"The U.S. berates China for its exchange rate policy, which Washington doesn't like," Mundell says. "But one-sided pressure on China to change its exchange rate is misplaced."
Mundell strongly believes that pro-growth tax policies and stable exchange rates are essential for turning around the economy. He sees the price of gold is an index of inflation expectations.
"The rising price of gold shows that people see huge amounts of debt being accumulated and they expect more money to be pumped out," he says.
Even so, Mundell hedges. "They might not necessarily be right; gold could be overvalued right now," he says.
Despite closing lower last week, the uptrend in the gold price remains intact, rallying to within 1 percent of $1,400 per ounce.
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