Sacrifice the currency or sacrifice the economy? That is the choice faced by the head of the US central bank, Ben Bernanke. It’s not a difficult choice really. Bernanke will make the same decision as Bank of England governor Mervyn King, i.e. he will sacrifice the currency.
Let’s Assume I’m Wrong
Let’s assume for a minute that Bernanke actually does pursue a “strong dollar policy”, what would happen. Well, in order to strengthen the US dollar the Federal Reserve would need to begin raising interest rates and cease (or even reverse it’s) asset purchases.
This would boost the purchasing power of US consumers, however it would also cripple those with large mortgage (or other types of) debt and would put millions more homeowners underwater. US exporters would find it impossible to compete with other manufactures around the world and a strengthening dollar would drive stocks, commodities and precious metals lower. All of which would help facilitate the cleansing of at least some of the massive debt that has been accumulated over the past decade.
It would be the right thing to do but it would inflict severe short-term pain on the US electorate. The US would likely enter a 3 year depression on the same scale as the 1930’s. This of course would be political suicide for president Obama and just as it did under Paul Volker the Fed would experience massive protests.
One thing we can be sure of however is that Bernanke is no Volker. He will sacrifice the currency every time.
The truth however is that sacrificing the currency only buys the economy time and does nothing to resolve the structural issues.