Mr. Baggins, you can put the effects of monetary policy much more succinctly, and completely, than I can. However, interest rates are heavily influenced by another factor given the world market, something not dealt with for introductory level economics. Please note, my economics education is basic, however, I consider history on ongoing process and have been watching the last twenty years and the new trends with some surpise, and concern. By the way, thank you for your explanation on how new treasuries are issued. I had assumed
that they were of course paying off the interest. Foolish me.
The global economy, and trade defecits, leaves the interest rate on long term US government debt up to a free market, very neatly dovetailing with your observation of the commoditization of the greenback. These auctions (you cannot get much more free market than that) set the effective interest rates for many critical forms of debt in the US economy, from mortgages to corporate debt.
Now add in the monetary supply factors as explained by Mr. Baggins, and you have a recipe for disaster. If the Euro is seen as a more reliable currency, with a central bank that is more reliable and more independent the other major currencies, world trade will shift over to it. It has already begun as Mr. Greenspan looses credibility oversees, and the relative value of the dollar deteriorates.
It's happened before. The pound sterling at the beginning of the 20th century was worth roughly $20 US (from memory). It closed the end of the century at under $2/pound. It lost its status as the world trade currency from the end of WW1 thru the end of WW2, due to a variety of factors, some of which resemble what is happening to the US now (and I'd like to keep this post under one screen
).
If the world shifts over to the Euro, as there are excellent indications it will, then the dollar will further weaken, and the
demand for US treasuries will fall, meaing the US (and the taxpayers servicing the debt) will have to pay higher, possibly substantially higher, interest rates. Remember, the pound sterling lost roughly 90% of it's buying power reference the dollar. It took the better part of a century, but it definitely had negative affects on the quality of life in GB as it happened. The increased inflationary factors (look at what is happening to commodity prices in the US as China competes for finite raw materials) will definitely negatively impact the quality of life in the US, and if combined with irresponisble government policies could easily produce something resembling Argentina, which after WW1 was one of the top 10 economies in the world!
Mr. Baggins, could you clarify one thing for me. From what I had understood reference monetary policy, if you have a tight monetary policy during a period of growth, you end up with deflation as you have the same amount of money circulating with an increased amount of services/goods in the economy. I realize that is why the Federal Reserve closely monitors it and divides it into the M1, M2, and M3 quantities.
http://www.frbsf.org/publications/federalreserve/monetary/glossary.html
Can you give me a short rundown on how those relate to inflationary/deflationary pressures, and any little hidden surprises in those factors that those of us with only a basic financial education might be missing.
