Dollar falls, then firms, as Fed commits $800 billion more to ease credit crunch

Posted Nov 25th 2008 2:10PM by Joseph Lazzaro
Filed under: Federal Reserve, Recession, Financial Crisis

The dollar fell, then firmed, against most of the world's other major currencies Tuesday at mid-day, on word of yet another U.S. government intervention to ease the financial crisis. (For full currency data, click here.)

Still, the more important theme, many economists and analysts agree, is how well the dollar has fared given the remarkable increase in debt by the United States and the supply of dollars globally.

The dollar weakened about one cent to $1.3040 versus the euro and about half a cent to $1.5160 versus the British pound on Tuesday at mid-day, after the U.S. Federal Reserve announced it would buy up to $600 billion in mortgage and mortgage servicer-related debt and up to $200 billion in consumer and small business-backed loans, to free up credit in these sectors. The dollar also fell about one cent to 95.53 versus Japan's yen, and about half a cent to $1.1881 versus the Swiss franc.

Under the new programs announced Tuesday, the U.S. Treasury will provide about $20 billion in credit protection to the U.S. Federal Reserve, using money from the $700 billion Troubled Asset Recovery Program (TARP).

In September, the Fed's balance sheet totaled $924 billion, when the first wave of the financial crisis began to freeze credit markets and decimate stock markets around the world. However, if all loan guarantees are accessed, and if all of the remaining $780 billion debt is added to the Fed's balance sheet, that balance sheet would increase to about $3 trillion.

The Fed's additional inventions are part of the 'new tool box' and unconventional techniques that Fed Chairman Ben Bernanke said most likely would be needed to help the nation cope with its most serious financial crisis since the Great Depression.

Although the Fed's actions announced Tuesday technically are not quantitative easing, they will have that effect, says economist David H. Wang. Quantitative easing involves increasing the reserves in the banking system after the Fed loses the ability to lower the cost of money from an interest rate standpoint.

Monetary Policy Analysis: The Fed's goal is to free up credit in much the same way it has freed up credit in financial institutions via other term auction facilities. The Fed will buy loans backed by mortgage issuers, small businesses, student loans, auto loans, and consumer credit cards, with the goal of adding dollars to these markets.

The danger is that the Fed adds too much money into the system and inflation increases. However, many economists argue that, at least until the economy recovers, the chance that inflation will rise is modest, given the plunge in housing, commodity, and stock prices in the U.S.

Will the dollar continue to decline? That depends. More dollars in supply suggest it should, but if U.S. economic growth resumes at the healthy rate, the attractiveness of U.S. investments, among other factors, may offset the increased dollar supply.

Tags: auto loans, consumer loans, dollar, euro, Fed, inthenews, loans, monetary policy, MonetaryPolicy, student loans, TARP, term auction facility, U.S. Treasury, yen