The reality is that we’re one panic away from foreign-exchange markets ripping free of central bank manipulation.
While all eyes on fixated on global stock markets as the measure of “prosperity” and “growth” (or is it hubris?), the larger force at work beneath the dovish cooing of central bankers is foreign exchange: the relative value of nations’ currencies, which are influenced (like everything else) by supply and demand, which is in turn influenced by interest rates, perceived risk, asset purchases and sales by central banks and capital flows seeking the lowest possible risk and the highest possible return.
Which brings us to Triffin’s Paradox, a topic I’ve covered for many years:
Understanding the “Exorbitant Privilege” of the U.S. Dollar (November 19, 2012)
The Federal Reserve, Interest Rates and Triffin’s Paradox (November 19, 2015)
The core of Triffin’s Paradox is that the issuer of a reserve currency must serve two entirely different sets of users: the domestic economy, and the international economy.
The U.S. dollar (USD) is the global economy’s primary reserve currency. When the Federal Reserve lowered interest rates to zero (Zero Interest Rate Policy, ZIRP), it weakened the dollar relative to other currencies. In this ZIRP environment, it made sense to borrow dollars for next to nothing and use this free money to buy bonds and other assets in other currencies that paid higher yields. Many of these assets were in emerging market economies such as Brazil.
As a result of this enormous carry trade, an estimated $7 trillion was borrowed in USD and invested in other currencies/nations.
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