Memories of Surpluses Past
Dave Lewis
The recent good news on the budget suggests that our longer-run prospects for continuing this beneficial process of recycling savings from the public to the private sectors have improved greatly in recent years..
Fed Chairman Greenspan, Monetary Policy Report to Congress, Feb 17, 2000
Remember when the gang in Washington was worried about the implementation of monetary policy due to the shrinkage in supply of US Treasuries? As recently as February of 2001, Fed Chairman Greenspan, in his testimony to Congress warned: However, the prospective decline in Treasury debt outstanding implied by projected federal budget surpluses does pose a challenge to the implementation of monetary policy. The Federal Reserve has relied almost exclusively on increments to its outright holdings of Treasury securities as the "permanent" asset counterpart to the uptrend in currency in circulation, our primary liability. Because the market for Treasury securities is going to become much less deep and liquid if outstanding supplies shrink as projected, we will have to turn to acceptable substitutes. Last year the Federal Reserve System initiated a study of alternative approaches to managing our portfolio.
A look at the above chart should dispel any lingering worries over Federal Reserve inability to implement monetary policy. Today's chart is a rehash of a previous look at the US fiscal balance as a % of GDP updated to include the May deficit and currently accepted forecast of $400B for this fiscal year, graphed vs. the Federal Reserve's Major Currency Real Dollar Index. As you can see, the dollar's gains in the 90s coincided nicely with the improvement in the fiscal balance.
Whether by intent or not, I imagine many foreign investors, who piled into US Treasuries while the "end of deficits" mantra was making the rounds, might be feeling a bit conned at the moment. Given the, in my view, near impossibility of a shift to higher tax rates any time soon, the only relief in this ratio will come from rising GDP. However with a protracted war in Iraq seeming more and more to be a central forecast and given the still tepid US economic response to past stimulus, deficits should continue to climb. To the extent the current US$ US fiscal deficit relationship continues to hold, barring something miraculous, the US$ looks to have much more room to decline.
Dave Lewis
www.chaos-onomics.com
dave.lewis@chaos-onomics.com
June 15, 2003
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