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The Fed Is Bungling the World's Reserve Currency

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

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Emerging Pressures

Of course, we've all heard stories that countries like China and Russia have been advocating that the world adopt a different reserve currency. Many dismiss China's and Russia's positions as political rants. But these gripes are legitimate, and the existing monetary and fiscal policies in the US will, eventually, move the world toward an alternative reserve currency system.

Policy Impacts

Congress certainly has, but the Fed, in particular, has been irresponsible as the caretaker of the world's reserve currency. Granted, the Fed and US never openly asked that the dollar be the reserve currency, but the US sure has taken advantage. Since such responsibility was never requested (but has been tacitly accepted), the Fed maintains that its only interest is in America's economic performance. But Fed policies, such as QE, have huge consequences offshore.

For example, when the Fed tells the capital markets that interest rates will be 0% for an "extended period," as it did in 2011 and 2012, hedge funds borrow dollars at miniscule yields and send those dollars to higher-yielding emerging market economies. The demand for the local currency increases its value vis-à-vis other currencies. The capital movements from Fed QE policies have been monstrous, often overwhelming the emerging economy's underdeveloped financial system, causing inflation in the local economy along with rising interest rates and slowing economic growth.

Last May, when Fed Chairman Bernanke used the word "taper," those huge flows, which had built up over a period of months, almost instantaneously reversed as the hedge funds raced to repay their borrowings before interest rates rose further. The result has been a collapse in emerging market currencies (India, South Africa, Indonesia). Remember, these capital flows have nothing to do with underlying economic activity but are simply capital flows caused by the policies of a single central bank: the Fed.

Conclusion

It isn't hard to see why other world players are upset with the Fed and the dollar as the world's reserve currency. In the absence of "gold" (((doesn't need to be in as the ultimate disciplinarian, which would limit money creation, and with "trust" as the only underlying asset, the Fed has been free to flood the world with dollars and manipulate capital markets, all to the detriment of emerging economies. The calls for a different system are based on economic facts and realities that cannot be denied. As a caretaker of the world's reserve currency, the Fed and its QE policies are an abject failure.
No positions in stocks mentioned.
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