The Federal Reserve is very nervous about deflation. The reason for this
is more than its awarenes of the grave danger of deflation on the
economy. The real reason is is that central banks in general, and the Fed
in particular, do not have the power or operative measures within their
discourse to deal with deflation. The exclusive dependence of central
banks on interest rate policy to fight inflation does not work for
fighting deflation, as a decade of data in Japan has shown. The Fed is now
following Japan's lead in trying to manage an exchange rate policy
(talking is not pushing the dollar down) to export deflation to its
trading partners.
The Chinese economy has been accused by some Japanese economists as
exporting deflation by stripping non-Chinese companies of their pricing
power. That is an obvious fact, but the cause of this does not origninal
from inside China. As I pointed out in an earlier post (Dollar's slide
and PPP), the Chinese currency, the RMB, is actually depreciating against
the dollar on a PPP adjusted basis, despite a nominal peg. Thus with the
US pushing the dollar down, it will only exacerbate China's deflation export.
The problem is not the relative value of the dollar, but the dollar's role
as the dominant reserve currency for trade. The use of exchange rates to
manage trade is a destructive move, regardless who does it. Exchange rates
need to be stable and to change only gradually and infrequently. Trade
needs to be structured to increase domestic wages rather than to push
domestic wages down. Pushing wages down decreases purchaing power
domestically which directly contracts international trade.
Central banks must change their theology of protector of the value of
money and start promoting full employment and rising wages worldwide and
alter an economic system that rewards corporate policies of layoffs and
cost cutting, to one that rewards job creation and expansion.
Henry C.K. Liu