Thursday, November 29, 2018

Beware the Shrinking US Dollar!

Popular Economics Weekly

Barron’s Magazine reported that the Fed is shrinking credit too quickly, and it will slow not only U.S. economic growth, but growth in the rest of the world as well. Why? Because the U.S. Dollar is the world’s main reserve currency that covers more than 60 percent of world trade.

And since the Fed is taking circulating $$ out of the economy by selling some of those $4 trillion in securities it has been holding since Fed Chair Ben Bernanke’s term--$50 billion per month—it is reducing the amount of dollars in circulation, leaving fewer dollars to pay for transactions via the world’s banks and clearing houses.

Over the four-week period from October 3 through October 31, reports Wolf Street, the Federal Reserve shed $35 billion in assets, according to the Fed’s weekly balance sheet released last Thursday afternoon. This brought the balance sheet to $4,140 billion, the lowest since February 12, 2014. Since October 2017, when the Fed began its QE unwind, or “balance sheet normalization,” it has now shed $321 billion:

And that could mean that China’s Yuan (Renminbi) and the euro would begin to replace it as reserve currencies, meaning that fewer transactions would flow through US banks and economy. This also means the US then has less control over trade rules, and yes, sanctions it wants to impose on other countries, like Iran. This is because other countries don’t like economic bullying that isn’t in their best interests, and will seek to use other currencies, such as the euro in place of the dollar.

The dollar leads all other currencies in supplying the functions of money for international transactions. It is still the most important unit of account (or unit of invoicing) for international trade. It is the main medium of exchange for settling international transactions. It is also the principal store of value for the world’s central banks, said a recent Bank of England Quarterly Bulletin.

But what can happen next, as worldwide growth slows, which is sure to happen as dollar reserves and credit shrink?? Trump’s trade war is happening at a very bad time. Economist and Project Syndicate columnist Jeffery Sachs has outlined the possibilities of trade policies that harm, rather than help economic growth.
“The most consequential and ill-conceived of Trump’s international economic policies are the growing trade war with China and the re-imposition of sanctions vis-à-vis Iran. The trade war is a ham-fisted and nearly incoherent attempt by the Trump administration to stall China’s economic ascent by trying to stifle the country’s exports and access to Western technology. But while U.S. tariffs and non-tariff trade barriers may dent China’s growth in the short term, they will not decisively change its long-term upward trajectory.
“More likely, they will bolster China’s determination to escape from its continued partial dependency on U.S. finances and trade, and lead the Chinese authorities to double down on a military build-up, heavy investments in cutting-edge technologies, and the creation of a yuan-based global payments system as an alternative to the dollar system.”
This is hardly making US safer, in a world that has outgrown dependence on US economic and geopolitical power. The US currently produces around 22 percent of world output measured at market prices, and around 15 percent in purchasing-power-parity terms (i.e., actual volume). Yet the dollar accounts for half or more of cross-border invoicing, reserves, settlements, liquidity, and funding.

We could be punching above our weight, as the saying goes, if we continue to bully our economic allies, as well as our adversaries. There are now other Heavyweights in the ring.  

Harlan Green © 2018

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