Could this be the beginning of a fall from grace?
The United States, according to Steven C. Johnson, Columnist at Reuters, the news and media division of Thomson Reuters, was the only country that was stronger at the end of World War II than at the start of the war.
“Since the end of the Cold War, however, foreign rivals have knocked it off it’s pedestal in a host of economic rankings. Today, for example, China is growing more rapidly than the United States, and many investors and historians alike see the European Union as its economic equal,” said Johnson.
“The United States is a power, but it’s hardly the only power, and it’s certainly not a superpower anymore,” said Jim Rogers, who co-founded the Quantum hedge fund with billionaire investor George Soros in the 1970s.
A global shortage
According to Michael Devereux, Multi-Asset Fund Manager at Schroders, November’s multi-asset chart of the month highlights how a global shortage of US dollars could be reversing. This could signal the beginning of a weak phase for the currency.
“A world in which money is scarce might appear to be a far-fetched idea. But for US banks in the business of taking deposits and making loans, this has become a reality,” said Devereux.
“Recently a global shortage of US dollars has emerged, which has driven the dollar from strength to strength against other currencies for the last five years, according to the broad dollar index. However, this shortage of US dollars is being alleviated by the recent actions of the Federal Reserve (Fed), which could be the beginning of a fall from grace for the currency known as the greenback, as explained below,” added Devereux.
New rules after the financial crisis
“The aftermath of the 2008 financial crisis saw a multitude of new rules and regulations for financial markets. The aim was to make sure such a damaging financial crisis could never happen again,” continued Devereux.
One of these new rules, Devereux said, was that the US central bank would pay interest on the excess reserves (the ‘IOER’ rate) of banks.
Where do banks put their money?
“US banks are required to hold a ‘bank account’ at the country’s central bank in which they must deposit a minimum amount in order to conduct their business. This minimum amount requirement is called Required Reserves. Deposits at the Fed above this level are called Excess Reserves and provide economists and investors alike with a useful barometer of the availability of US dollars in the financial system,” said Devereux.
Why is this useful? “In principle the more excess reserves available, the more money banks feel comfortable lending out,” added Devereux.
The supply of US dollars
“Through the 2008-2015 era of quantitative easing (so-called QE) the Fed made large-scale purchases of bonds. In effect this created new money, delivering US dollars into the financial system and increasing their availability – most banks could in theory lend out more US dollars,” emphasised Devereux.
Economic growth, Devereux said, improved markedly and the recovery in corporate earnings was reflected in the strong performance of US stocks…but once the policy stopped, banks did not step up.
“These policies were wound down in recent years, reducing the supply of US dollars. At the same time the behaviour of commercial banks has permanently changed. These institutions typically borrow money from each other and use safe assets such as US Treasuries to guarantee the loans (like a bank would ask for a deposit to guarantee purchase of a house),” Devereux added.
Instead of using these securities to borrow money however, Devereux mentioned banks are displaying more conservative behaviour and keeping these safe assets locked down. “Less lending in the financial system means slower household and corporate expenditure alike, all else being equal.”
“The US needs more dollars…lower supply means higher prices. The end result is that not only is the Fed supplying fewer US dollars to the financial system, but commercial banks are also supplying fewer US dollars to each other,” added Devereux.
The Federal Reserve to the rescue (again)
Smooth functioning of financial markets, according to Devereux, relies on the creation of credit and flow of liquidity. Commercial banks’ aversion to transforming safe assets into credit has impaired the flow of US dollar liquidity. That was displayed acutely in September by a sudden spike in the interest rates that banks charge each other for overnight loans. The Fed recognised the danger and stepped in to provide $250 billion worth of lending to financial markets.
“Having made another interest rate cut at its recent October meeting, the Fed is acting to make lending easier for everyone,” said Devereux.
“September’s display of funding stress and the Fed’s reaction to provide liquidity could prove a catalyst for a reversal in the trend of falling excess reserves. As such, it could also be the start of a weaker phase for the US dollar,” concluded Devereux.
Editor’s Thoughts:
As Devereux mentioned, the shortage of US dollars could be the beginning of a fall from grace for the currency. According to Johnson, experts say the consequences of the Dollar’s long term decline could have deep significance. Over time, the forces behind its decline could further marginalize the United States on the world stage. “Historically, no country that has gotten itself into this situation has ever come out without a crisis,” Rogers said. Do you believe we might be in a great amount of trouble? Please comment below, interact with us on Twitter at @fanews online or email me your thoughts [email protected]
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