Loan Modification

Buiter Suggests Torching Currency To Cause Inflation

By Implode-Explode Heavy Industries

Well, basically. Here is his favored method (out of 3 outlined):

The third method ends the fixed exchange rate (set at one) between dollar deposits with the Fed (reserves) and dollar bills. There could be a currency reform first. All existing dollar bills and coin would be converted by a certain date and at a fixed exchange rate into a new currency called, say, the rallod. Reserves at the Fed would continue to be denominated in dollars. As long as the Federal Funds target rate is positive or zero, the Fed would maintain the fixed exchange rate between the dollar and the rallod.

When the Fed wants to set the Federal Funds target rate at minus five per cent, say, it would set the forward exchange rate between the dollar and the rallod, the number of dollars that have to be paid today to receive one rallod tomorrow, at five per cent below the spot exchange rate?the number of dollars paid today for one rallod delivered today.

This method and the others more or less force the economy to start "baking in" a specific amount of inflation in the dollar. They aren't terribly sophisticated. They are the economic equivalent of simply burning dollars with certain digits in the serial numbers every once in a while (or less dramatically, declaring them worthless).

Of course none of this mad-scientistry would do anything to get people to save more, the very thing our economy really needs for long-term recovery (except, maybe, in gold, but since gold banks are effectively illegal, such savings is more useful for personal wealth preservation than building tomorrow's economy).

So all this could possibly achieve of "benefit" would be forcing inflation into house prices, possibly (in some measure) stimulating the real estate market. Perhaps Buiter and other central banksters think rising nominal home prices would do more than anything else to revive the economy.

We think they would sadly be mistaken: rising prices are unlikely to spark a buying frenzy not only because of the momentum of a falling market, but because incomes would likely lag earnings (as in all inflations), causing more people to fail to have enough income to qualify for the new mortgage loans.

At the end of the day, the poor and middle class would be poorer, for in their lack of agility, they would likely be less able to preserve the value of their dollar holdings; and small businesses would be further impoverished by losing money to inflation (again, as always happens in an inflation, where retail pricing power lags the inflation rate).

As for trade, any benefit by the falling dollar would likely be counteracted by the increasing prices of imported goods for consumers, not to mention, most of our major trade partners would simply copy our currency-torching policies, in a new race to the bottom.

Full post as published by Mortgage Lender Implode-o-Meter on September 12, 2010 (boomark / email).