Observation: Double-Edged Sword

The U.S. economy always has a profound effect on the world economy, generally speaking, affecting many smaller components of international economies, as well.

Fluctuations of the dollar are always a strong impact to the global economy. So the recent decision by the Federal Reserve (Fed) to pump an extra $600 billion into money market to boost the U.S. economy will act as a double-edged sword for both the U.S. economy and the world economy.

The Fed has already unleashed $1,750 billion into the money markets — however the U.S economic situation has yet to become very bright. Unemployment remains high, at nearly 10 percent, and the level of economic growth remains too low. The inflation rate is down to 0.8 percent. Thus, the specter of deflation is haunting Americans and is affecting their psych. The Fed’s decision to continue loosening monetary policy is rooted in that context. One can see that the Fed is very concerned about deflation and opted to accept inflation through this decision: injecting additional cash into money markets by buying government bonds, thus reducing the bond’s interest rate, thereby encouraging economic growth and investment in manufacturing and business.

In the short term, this thinking could work; in the medium and long term, however, these measures will do more harm than good because the interest rate is too low and the demand for new credit is not great. To the Fed, the biggest danger is that it will not be able to control inflation and the dollar will continue to depreciate. Devaluing the dollar helps to promote exports, but it is also increasing inflation. This may lead into an uncontrollable vicious cycle and if economy is not growing strong, then it would only do harm. It’s like someone playing with a knife: if they’re not careful, they will be cut.