Thursday, November 4, 2010

Federal Reserve Risks Ruining Reserve Currency

The Federal Reserve may be about to announce a second round of quantitative easing.
The Federal Reserve is expected to announce today whether or not to unleash a second round of quantitative easing. It may be one of the most important decisions in its history. Will the Fed sacrifice the dollar, and risk losing reserve currency status in an attempt to stimulate the economy and “painlessly” pay its debts?
The Telegraph’s Ambrose Evans-Pritchard is warning that the Fed’s quantitative easing plan “risks” a “currency war” that may accelerate “the demise of the dollar-based currency system, perhaps leading to an unstable tripod with the euro and yuan, or a hybrid gold standard.”
The problem facing the world is that the global economy is trapped in stalling speed. Most of the regular tools used by central banks have been exhausted. Interest rates are already near zero, and many governments have mostly spent what they can—and yet the global economy is sputtering.
All that is left for national economies is to try to gain export market share at the expense of their neighbors. To do this, nations are attempting to devalue their currencies to make their exports less expensive and imports more expensive. The risk, as Evans-Pritchard points out, is trade war.
Relations between China and America are especially strained. America wants to devalue the dollar and thus reverse its trade imbalance with China. China is resisting and is maintaining its dollar peg, which ensures that the yuan’s exchange rate remains fixed to the dollar. And the war is spreading. The Telegraph reports (emphasis ours throughout):
China’s Commerce Ministry fired an irate broadside against Washington on Monday. “The continued and drastic U.S. dollar depreciation recently has led countries including Japan, South Korea and Thailand to intervene in the currency market, intensifying a ‘currency war.’ In the mid-term, the U.S. dollar will continue to weaken and gaming between major currencies will escalate,” it said. …

Taiwan intervened on Monday to cap the rise of its currency, while Korea’s central bank chief said his country is eyeing capital controls as part of its “toolkit” to stem the flood of Fed-created money leaking out of the U.S. and sloshing into Asia. …

“It is becoming harder to mop up the liquidity flowing into these countries,” said Neil Mellor of the Bank of New York Mellon. “We fully expect more central banks to impose capital controls over the next couple of months. That is the world we live in,” he said. Globalisation is unravelling before our eyes.
Additionally, foreign nations are beginning to wonder if the Federal Reserve’s money printing isn’t designed to just lower the value of the dollar and increase exports, but also to monetize the debt. Is the Fed printing money so as to cheat its creditors and make debt payment easier for Americans? In 2009, the Federal Reserve created money to finance 80 percent of the U.S. budget. Depending on the outcome of the Federal Reserve’s announcement today, this year’s money-printing may approach similar magnitude.
Money printing of this scale cannot go on indefinitely—it is Zimbabwe policy. It will inevitably lead to the world adopting a new reserve currency; one that is a stable store of wealth and one that cannot be created with the click of a computer button. The Telegraph continues:
But whatever the rights and wrongs … the reality is that a chorus of Chinese officials and advisers is demanding that China switch reserves into gold or forms of oil. As this anti-dollar revolt gathers momentum worldwide, the U.S. risks losing its “exorbitant privilege” of currency hegemony—to use the term of Charles de Gaulle.
China is America’s most important creditor nation. Further, it is the world’s second largest economy, and the world’s largest exporter. China’s global importance as a major economic player has grown immensely over the past five years.
If China abandons the dollar, it could set off a mass exodus. Will a Federal Reserve decision to devalue the dollar be the catalyst?
“America is making a terrible mistake which will result in the greatest fall in all of mankind’s history!” J. Tim Thompson wrote for the Trumpet in 2000. “As soon as America is no longer a safe place for foreign money, that money will be gone. And once the foreign money is gone, it will leave us with a mountain of debt that we cannot repay.”
“So the question that Ben Bernanke and his colleagues should ask themselves,” says Evans-Pritchard, “is whether they have thought through the global ramifications of their actions, and how the strategic consequences might rebound against America itself.” As the Trumpet wrote in April 2006,
The question remains, how long will Japan and China continue to support the U.S. dollar? Each day they do, they add more dollars to their already massive dollar holdings. Demand for goods in America seems to be slowing, while European and Asian internal demand seems to be growing.

One day soon, foreign nations will not have the motivation to support the dollar and America’s massive deficits, because to do so simply will not benefit them any longer.

When that day comes, it will come as a giant knockout blow for the dollar ….