As the CCP virus pandemic brings business activity to a halt across much of the world, foreign central banks are facing cash shortages.
With so much of the global economy priced in U.S. dollars, the Federal Reserve is trying to relieve the massive liquidity crunch that’s occurring around the world. The Fed’s response has been to allow foreign central banks to swap their U.S. Treasury bond holdings in exchange for dollars.
Even though it’s described as a temporary arrangement, it’s still a bigger deal than many realize. In fact, it’s never been done before, not even during the 2008 Global Financial Crisis.
In effect, the Federal Reserve is acting like the central banker to much of the world, flooding the world with trillions of dollars to keep up with the liquidity demand.
Helping the World and the US
This new action by the Federal Reserve is particularly helpful to emerging economies, which have taken advantage of low-interest U.S. debt over the past few years.
With global business activity plunging in the first quarter of 2020, these smaller economies aren’t the only countries seeing their export volumes crash as the CCP virus pandemic spreads worldwide. But it does make them more vulnerable, since they’re still on the hook for servicing their dollar-denominated debt.
The Fed’s new liquidity scheme is designed to help those countries weather the liquidity and recession storm by allowing their economies to function with dollars in their system that would ordinarily not be there under the current exceptional financial and economic circumstances. Notably, the facility doesn’t add to a country’s central bank reserves. Rather, it just changes the composition of the reserves to cash from debt.
By extending this option for foreign governments to meet their cash needs in this very challenging time, it’s allowing central banks to access cash without having to print more of their currency in order to buy dollars. This helps avoid inflationary pressure in an environment that’s already heading toward increased scarcity of goods due to mass shutdowns of factories.
Although very helpful, at least in the short term, it’s not purely altruism on the part of the Federal Reserve. As uncontrolled demand for dollars rises in a crisis, such as the one the world is in at the moment, the dollar gains strength relative to other currencies. That’s made worse if other currencies are devalued by excessive printing in order to buy more dollars, because the dollar becomes relatively more valuable.
Of course, a stronger dollar hurts American producers by making their goods and services more expensive. That, in turn, often results in a fall in sales for U.S. producers, adding more recessionary pressure in the economy than there already is.
Providing needed liquidity abroad, therefore, not only supports the dollar-denominated financial system, and protects those countries participating in the Treasury bond-for-cash swaps, but it also protects the U.S. economy as well. It also underscores the Federal Reserve’s integral role in the current global financial system. A system, by the way, that China, Russia Iran, Turkey, and other rogue or contrary nations would like to see ended.
Risks and Downsides
But downsides and risks remain. According to Harvard University professor Carmen Reinhart, the dollar’s position in the global economy relative to the competing currencies, such as the euro, has actually become stronger today than it was during the 2008 Global Financial Crisis.
That may seem like an advantage, and in some respects, it is. It gives the United States the rare privilege as the world’s single reserve currency, which means it can borrow much more because demand for it is much higher than if, say, the euro were still at relative parity with the dollar.
But it’s not.
The post-Brexit euro has weakened, not only due the significant loss of the British economy, but also because of the disjointed and cratering economies in Italy, Spain, Greece, and even France. There’s real doubt as to the continued viability of the eurozone as an economic entity, and the euro as a competing currency to the dollar or even remaining a currency at all.
Without question, the world is almost wholly dependent upon the highly liquid U.S. Treasury debt market and the dollar.
Paradoxically, therein lies the risk to the global economy. Reliance upon one economy and its currency is inherently unstable. Furthermore, without a competing currency, the global reliance on the dollar that is itself freighted with tens of trillions of dollars in debt, and soon to be more trillions of new debt added on, how long the world continues to value it as a store of value is difficult to say.
Toward Synthetic Hegemonic Currency
In fact, at the Federal Reserve’s annual conference in Jackson Hole, Wyoming, last summer, then-Bank of England Governor Mark Carney warned that the dollar’s primary position in the world was risky. He also noted that it couldn’t last forever and shouldn’t. He suggested that the dollar itself should be replaced by a global digital currency.
As I discussed in my last piece, replacing the current dollar with a digital version or some other globally acceptable digital currency is more than just a passing thought. It will happen, and sooner rather than later. Carney argued for a Synthetic Hegemonic Currency (SHC) comprising a basket of major central bank synthetic currencies to reflect the economic strength of each.
In some ways, the Federal Reserve’s latest actions are proscriptive of both the advantages of a global central bank and the risks of overreliance on a single currency in a highly unstable global environment. What’s more, it would likely allow the world a way out of the liquidity trap of low interest rates and low growth rates, while protecting the world from the exaggerated impacts of economic policies and cycles experienced in the United States.
That’s not an endorsement, by the way; far from it.
For President Donald Trump’s “America First” foreign policy—a de-globalization push if there ever was one—to continue, maintaining the U.S. dollar and the national sovereignty that goes with it are critical.
On the other hand, those in favor of globalization see an SHC as the ultimate path to empowering global institutions that would be replacing national sovereignty. Replacing the dollar and other national currencies is the key to doing so.
James Gorrie is a writer and speaker based in Southern California. He is the author of “The China Crisis.”
Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.