In early 2010, the economic recovery was bustling along quite nicely. In fact, the Federal Reserve was beginning to hold talks behind closed doors concerning when it would be appropriate to begin removing accommodative monetary policies from the economy. At the outset of the 2008 Global Credit Crisis, the Fed had slashed short-term interest rates to historically low levels in an attempt to stave off another Great Depression. These extreme measures were apparently enough to save the economy. Furthermore, the Fed’s quick actions of 2008 were seen to be so successful that Time Magazine named Federal Reserve Chairman Ben Bernanke “Time Person of the Year”!
Therefore, by early 2010 key economic data began showing infant signs of a self-sustaining recovery. No one knew for sure when the Federal Reserve would hike interest rates and begin returning monetary policy to more “normal” standards, but market expectations were calling for the Fed to begin a tightening cycle by mid-to late 2010. Well, here we are in Q4 2010, and instead of considering tightening measures, the Federal Reserve is currently considering expanding the Fed balance sheet by another $500 billion to $1 trillion in an attempt to stimulate economic growth and fight off the supposedly imminent threat of deflation. The question we should be asking is—what the heck went wrong?
Liquidity Trap
It is always difficult to identify what exactly went wrong in the very middle of a crisis. Generally, hindsight makes it clear. Although it is a bit difficult to identify exactly why the current U.S. recovery is faltering and facing such extreme challenges, there are a few key problems that are definitely not helping.- Tight credit markets
- Weakened demand for credit
These two problems are very real and are definitely causing the U.S. recovery to struggle and forex trading remain volatile. Let’s break each of them down a bit further.
Tight Credit Markets
The United States economy is credit-based. Businesses function and operate by using credit lines. Therefore, when credit dries up, businesses contract. Businesses that are highly leveraged and have little cash reserves will fail, and businesses that do have large cash reserves will generally cut back on operations in order to protect against further loss. In both of these scenarios, jobs are lost and it sends a ripple effect through the economy that is very difficult to even out.Federal Reserve Chairman Ben Bernanke has acknowledged the fact that credit markets are very tight. The Federal Reserve is considering another round of quantitative easing, largely in an attempt to stimulate economic growth by loosening credit markets.
Weakened Demand for Credit
Businesses that are still healthy are by and large—scared. They do not want to expand business operations because they are fearful that their business operations will not remain healthy. Therefore, they are not wanting more credit. They are focusing on building stronger cash reserves in expectation that the economy is going to deteriorate further.Thus, this deadly combination—tight credit and weakened demand for credit by healthy businesses—has created a liquidity trap in the U.S. A liquidity trap is complicated, but essentially it means that further stimulus measures from the Federal Reserve will not stimulate economic growth. The answer is not to increase the money supply because there is already enough money in supply. The need is for banks to begin lending their huge excess reserves and for businesses to begin spending, but both of these are virtually impossible when confidence has been lost. A forex broker offers charts and price information on the rise and fall of the U.S. dollar.
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