The testimony of new Fed chief Ben Bernanke to Congress over the last two days, the questions asked and the press coverage of the spectacle reveal a lot about the disjointed thinking on economic policy in this country. On the one hand,
Federal Reserve Chairman Ben S. Bernanke, barraged Thursday with lawmakers’ questions about rising foreign ownership of U.S. assets, played down fears that China held enough dollars to endanger the U.S. economy.
So, lawmakers are scared to death that the Chinese will dump dollars (or more accurately dollar denominated securities) and drive down the value of the dollar.
Then on the other hand,
The Bush administration, as well as lawmakers, has grown increasingly frustrated with China, particularly over its reluctance to let its yuan currency rise in value to reflect its growing market power.
U.S. Treasury Secretary John W. Snow strongly hinted Thursday that the Treasury was considering naming China a currency manipulator in a report scheduled for release in April â€” a step that could open China to U.S. trade retaliation.
So, we’re considering “retaliation” against the Chinese because they aren’t dumping dollars.
Meanwhile, two things fed last years “record” trade deficit – a sound economy and a sound currency. Pumping up interest rates may slow the economy, but doing so while the Japanese and the Europeans keep theirs low is keeping the dollar strong. Lowering those rates may make US goods more competitive by weakening the dollar, but the lower cost of borrowing for consumers will mean potential inflation and a bigger debt financed trade gap. Any interest rate moves aimed at improving the trade deficit are going to have other consequences that will worsen it. That basically leaves some sort of systemic change to improve productivity – lower tax rates, a change in the tax structure, less regulation or, ironically, free trade – as the best tool to keep the trade gap in reasonable bounds.