The U.S. Dollar: One Cannot Escape Globalization

Forget globalization?

One cannot forget globalization in today’s world.

For one thing, financial markets won’t let us.

We are connected, whether we like it or not.

And, all things within the global world are relative.

In the current environment, the United States is strong relative to almost any other country in the world.

The value of the U.S. dollar in foreign exchange markets is the highest it has been in…how long?

And, as a consequence, many countries are suffering.

This, of course, is the other side of the page, the one where the U.S. dollar in foreign exchange markets was not doing so well. The U.S. dollar was weak.

And, as a consequence, many countries prospered, taking advantage of the weak dollar.

Almost everyone is connected.

We cannot live isolated from others.

The Dilemma

We read from Joe Rennison and Isabella Simonetti in the New York Times:

“Compared with other currencies, the U.S. Dollar is the strongest it has been in two decades.”

“It is rising because the Federal Reserve has increased interest rates sharply to combat inflation and because America’s economic health is better than most.”

“Together these factors have attracted investors from all over the world. Sometimes they simply buy dollars, but even if investors buy other assets, like government bonds, they need dollars to do so–in each case pushing up the currency’s value.”

“That strength has become much of the world’s weakness.”

“The dollar is the de facto currency for global trade, and its steep rise is squeezing dozens of lower-incomer nations, chiefly those that rely heavily on imports of food and oil and borrow in dollars to fund them.”

The result?

“Some countries are already in default.”

“Others are on the brink.”

“Of the 94 emerging market sovereign debt funds that S&P rates around the world, over a quarter rank as B-minus or lower, a low-quality rating indicative of a high-risk investment.”

In the 1980s, a debt crisis similar to the present one, crushed Latin America as the United States fought to defeat inflation.

Mr. Rennison and Ms. Simonetti quote Pramol Dhawan, head of emerging markets at PIMCO:

“It’s by far the worst year for outflows the market has ever seen.”

And, things seem to be just starting.

The Solution?

Here we are back in the world of radical uncertainty.

The Federal Reserve is focused on inflation in the United States.

The Federal Reserve has just at the beginning of this battle to bring U.S. inflation back down to 2.00 percent.

The Federal Reserve plan, as it is now being executed, is to reduce the size of the Federal Reserve’s securities portfolio.

As currently stated, the Fed intends to reduce the size of its securities portfolio by about $95.0 billion every month out until sometime in 2024.

So far, since March 16, 2022, the Fed has been able to shave $160.0 billion off of its balance sheet.

This is referred to as “quantitative tightening.”

The last major policy move of the Fed generated a period of “quantitative easing” which the Federal Reserve executed for much longer than just one year.

This effort of “quantitative easing” saw the Fed increase its securities portfolio by about $120.0 billion per month from February 2020 to December 2021.

Note, that the current effort of “quantitative” policy programs is the third time that the Fed’s major thrust has been buying (or selling) securities monthly for an extended period of time.

The first such “quantitative” effort was made under the direction of its creator, Ben Bernanke, who created this kind of policy effort to produce “wealth effects” in the economy to speed up, or, slow down consumer spending.

Mr. Bernanke created this policy plan to help the United States get out of the Great Recession and then to stimulate consumer spending during the following recovery.

The Federal Reserve, under Mr. Bernanke’s leadership, executed three rounds of “quantitative easing” that contributed to the United States producing its longest economic recovery since the end of World War II.

Why are these “quantitative” programs built this way?

Well, the goal of these “quantitative” programs is to create rising (or falling) stock prices that will generate the type of consumer spending desired by the Fed.

The size of the monthly change must be large enough to catch the eyes of investors and the length of the program must be long enough so that stock prices move continuously in one direction until the results achieved are what Federal Reserve leaders want.

It must be noted that right now, the Fed is encountering some problems in this respect.

The first two times, when the Fed engaged in a policy of “quantitative easing” the stock markets caught on quickly and the movement of stock prices followed the increase in the Fed’s securities portfolio.

The stock market, in both cases, went up and up and up!

Currently, investors have not jumped on the program and, as a consequence, the stock market is producing some greater volatility, something that did not happen when the Fed was trying to increase stock prices.

Investors, at this time, seem to be looking for reasons that will cause the Fed to “back off” from its “quantitative tightening.”

But, leaders within the Federal Reserve keep on saying to the market…”We are going to stick with the program.”

The Problem

The problem has been stated above.

The Federal Reserve is focused on stopping inflation in the United States.

The Fed’s program to combat inflation is based on the premise that the Fed will be able to shrink its securities portfolio by a specific amount for a year or more.

Whereas the Fed could ignore the rest of the world when it was added securities to its portfolio and generating lots and lots of liquidity for the world, the Fed cannot act all on its own when shrinking the size of its securities portfolio and reducing world liquidity on a steady basis.

There seems to be a conflict here.

Investors may be right in claiming that the Federal Reserve will have to, sooner or later, “back off” from its current monetary policy stance.

If the Fed continues with its plan, there may be a very serious problem that arises in the market for emerging debt.

In addition, there may be other debt markets that have “bloomed” in the past two or three years, that may be in similar straits.

Some people have expressed serious concerns about the “blank check” companies, the Special Purpose Acquisition Companies, that flourished during the period when the Fed was pumping money into the banking system, but now find 40 percent or more of the firms in deep trouble.

“Quantitative tightening” may not be able to work.

The Fed may have to back off!