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The Fed Is Bungling the World's Reserve Currency


The mishandling is so great, in fact, that the dollar is now at risk of losing its status.

The Fed has proven to be a terrible caretaker of the responsibilities that come with reserve currency status, even while the US economy benefits greatly from it. The bungling is so great that the dollar is now at risk of losing that status and, with it, huge benefits.

Some History

After both world wars, the US had the strongest economy. Despite FDR's removal of the US from the gold standard in 1933, the Bretton Woods agreements of 1944 established a "gold exchange" standard wherein balance-of-payments-deficit nations were to settle up with surplus nations in gold (at $35/oz.). Under this system, when gold payment settlements were made, the gold was never physically shipped but simply "moved" to the designated holding vault for the recipient country. In 1971, President Nixon removed the world from the gold exchange standard when France demanded physical delivery. Since then, the dollar has served as the world's reserve currency instead, with "trust" as the only underlying asset.

The Benefits of Reserve Currency Status

Most international transactions today occur in dollars even if neither of the transacting parties are American. For example, if Hyundai (OTCMKTS:HYMLF) of South Korea sells autos to a business in Argentina, the buyer must first convert the Argentina peso to dollars to pay for the autos. Hyundai can either hold the dollars or convert them to their home currency (won) Note that this transaction has little to do with US economic activity. Yet, it means that there has to be a lot of dollars floating around to support worldwide trade.

The reserve currency status and trust in the US dollar has resulted in the US government's ability to overspend and issue debt because of the demand for dollars in international trade.

On the other hand, when an emerging economy's government runs a large and systemic deficit, there are serious fiscal consequences. The value of the currency immediately falls, inflation occurs, and the markets force up interest rates thus impacting that economy's growth.

The reserve currency status and the accompanying trust in the currency have also resulted in the investment of excess dollars in the international system back into US Treasury securities.

Of the outstanding marketable US debt not held by US government agencies or the Fed ($11.9 trillion), $5.6 trillion is held by foreigners -- the largest two holders being China ($1.27 trillion) and Japan ($1.15 trillion).
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