“Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.”
So says the FOMC on June 23.
With it always being necessary to read between Bernanke’s lines, what exactly does “developments abroad” mean in terms of their impact on our economic growth?
Well, no one needs to be reminded that Mr. Bernanke is a student of the Great Depression, having written extensively on it. His contention that a contraction in Money Supply was at the heart of the matter and that “[The Fed] did it, we’re very sorry, and we won’t do it again” is at the root of his theoretical framework.
In other words, Bernanke sees recovery coming from the availability of money…in short: inflation ‘good’, deflation ‘bad’.
There are two major deflationary developments abroad that are causing the FOMC concern: 1) sovereign debt default risk in Europe and 2) refusal of China to allow the Yuan to appreciate against the dollar.
European austerity measures, and more specifically Germany’s plans to reign in its deficit, means fewer bailouts for bankers holding the shaky sovereign debt of the PIIGS. This will translate into higher default risk, falling bond prices, and rising interest rates. Oh yeah, and a higher preference for hoarding cash rather than investing it.
The other “development abroad”, China, has made only hollow efforts towards permitting the Yuan to appreciate. China, like all good Mercantilists, likes a fat export surplus. They achieve it by selling Americans their chotskies for dollars and then, rather than buying American goods with those dollars, they hoard the little green pieces of paper. Thus China’s weak Yuan policy is ‘deflationary’ for the US as it reduces US money supply.
These deflationary pressures are causing the FOMC their heartburn as they believe inflation is the source of economic growth.
