Should Britannia Rule The Currency Waves Again?
The U.S. dollar is the global reserve currency. Should it be? If other central banks are going to fix their currencies to another currency, shouldn't that currency be associated with a relatively low rate of inflation? After all, a reserve currency is supposed to function as a store of value. The chart below shows the consumer inflation rates of the U.S., the U.K. and the Euro-zone calculated on the same basis - the so-called harmonized index of consumer prices (HICP). As you can see, the year-on-year inflation rate in the U.K. has tended to be the lowest of the three since December 1998 and the U.S. inflation rate has tended to be the highest. As of May, HICP inflation rate for the U.S. was 4.43%, for the Euro-zone 2.47% and for the U.K. 2.20%. From December 1997 through May 2006, the compound annual rate of HICP inflation for the U.K. has been 1.43%, for the Euro-zone 2.01% and for the U.S. 2.61%. Back in the good old days of the gold standard, the British pound was the reserve currency because the Bank of England managed monetary policy in such a way as to keep the pound price of an ounce of gold constant. So, if another country pegged the value of its currency to the pound, it effectively was "tying up" to a stationary anchor. By pegging its currency to the U.S. dollar now, a country is tying up to a dragging anchor. Why do you think the People's Bank of China (PBOC) is having to tighten monetary policy now? Because the U.S. dollar is dragging China into higher inflation - inflation in the original sense of the word, excess money creation. If the PBOC is serious about slowing Chinese money supply growth, it will have to be more reluctant to support the U.S. dollar vis a vis the yuan. The support entails the purchase of dollars with freshly-printed yuan. But the PBOC is trying to slow the growth in yuan, not increase it. Things could get very interesting in the second half of the year as the dollar starts to sink because of very soft real GDP growth and a Fed on hold.
Harmonized Index of Consumer Prices
(year-on-year percent change)
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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