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One Monetary Policy Fits All – Part II

November 30, 2022

One Monetary Policy Fits All – Part II

In Part one of this series, Our Currency The World’s Problem, we discuss the vital role the U.S. dollar plays in the global economy. With an understanding of the dollar’s role as the world’s reserve currency, it’s time to discuss how the Federal Reserve’s monetary policy machinations influence the dollar and, therefore, the global economy and financial markets.

Given the Fed’s recent extreme monetary policy actions, which haven’t been seen in over 40 years, it is more important now than ever to appreciate the potential global consequences of the Fed’s stern fight against inflation.

Triffin’s Paradox

In Part 1, we highlight the following two lines, which help describe Triffin’s paradox.

“To supply the world with dollars, the United States must consistently run a trade deficit. Running persistent deficits, the United States would become a debtor nation.”

“Simply the growing divergence between debt and the ability to pay for it, GDP, is unsustainable.”

Increasingly borrowing without the means to pay it off is unsustainable. The terms zombie company or Ponzi Scheme come to mind when considering such a system. That said, because the printer of the currency and taxer of its citizens is in charge, we can only ask how long the status quo can continue.

The answer is partially up to the Fed. The Fed can use QE and low-interest rates to delay the inevitable. As we now see, the problem is that those tools are detrimental when there is high inflation. Fighting inflation requires higher interest rates and QT, both of which are problematic for high debt levels.

Financial Tremors

The Bank of England is bailing out U.K. pension funds. The Bank of Japan uses excessive monetary policy to protect its currency and cap interest rates…

…click on the above link to read the rest…

The Distortions of Doom Part 2: The Fatal Flaws of Reserve Currencies

October 10, 2018

The Distortions of Doom Part 2: The Fatal Flaws of Reserve Currencies

The way forward is to replace the entire system of reserve currencies with a transparent free-for-all of all kinds of currencies.

Over the years, I’ve endeavored to illuminate the arcane dynamics of global currencies by discussing Triffin’s Paradox, which explains the conflicting dual roles of national currencies that also act as global reserve currencies, i.e. currencies that other nations use for global payments, loans and foreign exchange reserves.

The four currencies that are considered global are the US dollar (USD), the euro, the Japanese yen and China’s RMB (yuan). The percentage of use in each of the three categories of demand for the reserve currencies–payments, loans and foreign exchange reserves–are displayed below.

Many observers don’t seem to grasp that demand for reserve currencies extend beyond payments. Many of those heralding the demise of the USD as a reserve currency note the rise of alternative payment platforms as evidence of the USD’s impending collapse.

But it’s not so simple. Currencies are also in demand because loans were denominated in that currency, so interest and principal payments must also be paid in that currency. There is also demand for the currency to be held as foreign exchange reserves–the equivalent of cash to settle trade imbalances and back the domestic currency.

Notice the minor role played by the yen and yuan, despite the size of the economies of Japan and China. There’s a reason for this that’s at the core of Triffin’s Paradox: any nation seeking to issue a reserve currency must export its currency in size by running large, permanent trade deficits (or an equivalent mechanism for exporting currency in size).

…click on the above link to read the rest of the article…

Triffin’s Paradox Revisited: Crunch-Time for the U.S. Dollar and the Global Economy

April 5, 2016

Triffin’s Paradox Revisited: Crunch-Time for the U.S. Dollar and the Global Economy

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.

…click on the above link to read the rest of the article…

The Federal Reserve, Interest Rates and Triffin’s Paradox

November 19, 2015

The Federal Reserve, Interest Rates and Triffin’s Paradox

There is no way Fed policy can be win-win-win for all participants.

One result of the global dependence on central bank interventions is a unhealthy fixation on the slightest changes in those interventions, oops I meant policies.

Since the slightest pull-back in central bank inflation of asset bubbles could spell doom for the global economy and everyone holding those assets, the world now hangs on every pronouncement of the Federal Reserve in a state of extreme anxiety.

Why the extreme anxiety? Because any change in Fed intervention creates both winners and losers. There is no way Fed policy can be win-win-win for all participants, and to understand why we turn to Triffin’s Paradox, a.k.a. Triffin’s Dilemma.

The core of Triffin’s Paradox is that the issuer of a reserve currency must serve two quite different sets of users: the domestic economy, and the international economy.

Triffin’s Paradox has two basic parts:

1. Any nation that issues the reserve currency must run a trade deficit to supply the world with surplus currency to hold in reserve and as a result,

2. The issuing nation faces the paradox that the needs of global trading community are generally different from the needs of domestic policy makers.

The global trading community requires that the issuer of the reserve currency run trade deficits large enough to satisfy the demand for reserves, while domestic audiences want a strong export sector, i.e. a trade surplus.

You can’t have it both ways: if you want to issue a reserve currency, you have to run a trade deficit that is commensurate in size with the global demand for your currency.

Since supply and demand set price, this push-pull affects the value of the U.S. dollar: U.S. exporters want a weak dollar to spur foreign demand for their products, while foreign holders of the USD want a strong dollar that holds its value/purchasing power.

…click on the above link to read the rest of the article…

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