Is reserve currency status an economic blessing or a curse? The answer might seem obvious, as reserve currencies have been shown to confer lower borrowing costs on their issuers. But what of the borrower who, enticed by low interest rates, borrows more than they can pay back? Naturally the result will be a default. However, for the issuer of a reserve currency that is unbacked by a marketable commodity, such as gold, in the event that they borrow too much, they can just print more currency. While this avoids default indefinitely, it also hollows out the economy, erodes the capital stock, reduces the potential growth rate and, eventually, leads to a dramatic devaluation of the currency and loss of reserve status. History has not been kind to countries that have followed this path. In my view, the grave investment risks associated with the US dollar’s inevitable and potentially imminent loss of reserve status are not priced into financial markets.
A more than one trillion dollar debasement in 2013 is now apparent.
Last week, the Federal Reserve announced an expansion of its bond-buying program consisting in large scale purchases of long-term treasury securities.
These purchases come in addition to the monthly $ 40 billion in mortgage-backed securities (MBS), the so called QE3, launched in September of this year. This means that now, monetary expansion will be equivalent to a total of $85 billion a month. Simply put, this is an unprecedented rate of currency creation for the FED.
Thus, a more fitting name for this latest round of easing would be QE4Ever (QE forever).
The novelty in the Fed’s most recent statement is that for the first time it has linked its bond purchases to specific economic parameters.
The FED stated it would hold its target interest rate (currently between 0 and 0.25%) and continue easing for as long as unemployment remained above 6.5% and inflationary expectations did not exceed 2.5%.
How did the FED select the given unemployment rate parameter?
Perhaps it is associated with the fact that unemployment sat at 6.5% at the cusp of the financial crisis in October of 2008.
If the labor market does not improve substantially (hint, hint… it won’t) the FED’s Open Market Committee will continue its purchases of Treasuries and MBS indefinitely with a likely possibility of increasing these purchases in the future.
The central point for stock markets is that this ultimately leads to a trap. In the future, positive employment data could be judged as negative, by signaling an end or a reduction to the FED’s stimulus to an economy that has become dependent on it. This would be negative for stock markets, as it is no secret that there exists a direct correlation between monetary stimulus and rising stocks.
However, we must realize that Ben Bernanke, FED chairman, is not willing to tolerate high unemployment nor is he willing to tolerate falling stock markets. This exposes an already evident problem: QE dollar debasement will remain the essential wonder drug to sustain this ficticious notion of a “recovery”.
A simple reminder that in order to lower the unemployment rate from its peak of 10% in October of 2009 to 7.7% in November of 2012, the FED added $ 1.8 trillion to the currency supply, today closer to $ 2.7 trillion (see chart). A high price.
At the advertised rate, in less than a year, the FED’s balance sheet could be approaching $ 4 trillion or beyond.