Posted by: Michael Mandel on March 17
We now have to think the unthinkable: What if the combined resources of the Federal Reserve and the U.S.. government are not enough to prop up the financial markets? What if the size of the financial crisis is so big that all the interest rate cuts, all the new ‘facilities’ get swallowed up? What if global investors lose so much faith in the dollar that money starts flowing out of the country as fast as it flowed in?
It could happen. The U.S. could be sliding into the major dollar crisis that pessimistic economists have been predicting since the 1980s. If the dollar drops too fast and too far, global investors will see the value of their investments in the U.S. plummet. That will make even safe Treasury securities look a lot less appealing, which will push global investors to pull their money out of the U.S. In turn, that makes the dollar drop even more.
This is precisely the sort of self-reinforcing feedback loop that the Federal Reserve was originally created to deal with. But here’s the problem: The Fed cannot protect the dollar. The Fed’s best—and only—weapon for fighting financial collapse is printing money. But the more dollars it prints, the faster the dollar will fall.
We know what the answer should have been: A global economy needs a global central bank, with the ultimate authority to print money and regulate the financial system around the world. I’ve written about this before, in my 2006 cover story “Can Anyone Steer This Economy?”. Back then I wrote:
Finally, a Big Big Idea—probably too big to even consider right now—would be the creation of global institutions for governing the world economy. History tells us that market economies are prone to financial crises, to which the only solution is a strong central bank. During the Asian financial crisis of the 1990s, for example, the Fed played that role.
But with the explosive growth of China and India, that sort of role for the Fed is no longer feasible, and no new institution has arisen to take its place. As former Treasury Secretary Robert E. Rubin, now a top official at Citigroup, recently said: “There’s no policy mechanism for bringing together the countries that really matter in the global economy.” The best solution would be some sort of global central bank with real powers—but that’s not going to happen until there’s a big enough financial crisis to truly scare people.
Other people have written about the need for a global central bank as well. But we don’t have a global central bank, and it’s not possible to put one in place right now. Instead, what may be necessary is a global bailout of the U.S. financial system. Wall Street firms need funding, but it should be in euros,yen and yuan rather than dollars.
Moreover, when it comes time to pump money into the housing sector, much of the funding may need to come from overseas, in the form of non-dollar-denominated investments. These won’t come cheap, because of the declining dollar. But money from outside the system is essential.
This is going to be an enormous write-down of the U.S. financial system. It won’t be easy, and it won’t be pleasant. But global cooperation may be the only way to go.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.