By David M. Fields
So, what is the Fed’s deal? Has Jerome Powell fallen prey to inflationary paranoia and hysteria for all the wrong reasons? Or is a “strong’ dollar a manifestation of a particular response to a policy choice that is more calculated and direct? By facilitating aggressive monetary austerity, the Federal Reserve is ensuring the US dollar is a safety asset to insulate the global rentier from cost-push-markup inflationary unpredictability.
The US dollar is surging to new heights. For instance, the US Dollar Index, which values the greenback against a basket of currencies, has advanced considerably. One of the burning questions is whether this will last? For now, I think, yes, it will, simply because there is no alternative for global trade invoicing and financial accounting. Aggressive monetary austerity policy from the Federal Reserve, a project aimed at using unemployment to tame cost-push-markup inflation, is pushing rival currencies lower, particularly in emerging market economies that suffer from balance of payments constraints, as investors from around the globe rush to purchase US Treasuries for security in the face of world-systemic economic uncertainty.
This scenario is vastly different than the monetary policy from only a year ago or so. Then, to cope with the Covid-19 pandemic, central banks around the world cut interest rates sharply — to near 0 — and governments deployed aggressive fiscal support of their economies. As a result, Federal Reserve actions were important in stabilizing world financial markets, specifically with respect to Fed swap lines and the establishment of the Foreign and International Monetary Authorities (FIMA) Repo Facility, which ensured a “buyer of last resort” for foreign central banks desiring to sell U.S. dollar reserves. Capital flowed throughout the world and the dollar fell sharply. In a sense, this was to be expected, and was seen as temporary. Eventually, the dollar was bound to bounce back up. And now it is. And the post-pandemic world paved the way.
Indeed, as the world economy reopened from pandemic lockdowns, supply chain bottlenecks arose, coupled with pandemic profiteering, generating worldwide upsurges in inflation. The response from the Fed, as mentioned, has been to raise the federal funds rate, which has translated into a sharp dollar appreciation as a result of global capital inflows, as the US dollar is a reserve asset to cope with worldwide economic uncertainty.
Yet, is this influential role of the dollar in the world economy an indication of the United States’ core commitment to internal price stability and external cooperation for the deliverance of efficient world capital markets and global trade links? Or acute deposition of the monetary power of the United States? In my view, the answer is the latter.
The Fed is the world economy’s central bank, which acts as the safety valve for mass amounts of international liquidity. The role of the US dollar in international markets, and the advantages that come with it, are the spoils of its monetary hegemony. The provision of this asset allows the United States to become the source of global demand, and to insulate itself from fluctuations and contradictions of perilous cumulative disequilibria that may arise in the world economy, like the adverse price effects of supply chain bottlenecks and financial contagion that stem from foreign currency devaluations. The US dollar is the numeraire currency in international markets, which is not emblematic of credible macroeconomic performance that fosters confidence, but an arbiter of authority that regulates and dictates the flows of international financial commitments for global economic activity.
Given the current state of world economic dynamics, along with the foreseeable future, there does not seem to be a direct challenge to the dollar’s preeminence, in the same vein as the Euro was not a likely contender given its fallout from the Great Recession. There is not any indication of the greenback’s fall from grace as the dominant international currency. This does not preclude, nevertheless, eventual dollar dethroning, just confirms that the process is (very) long-term.
Despite hysterical contestations of inflationary fragility, the US dollar insulates the United States from global fluctuations and contradictions that may arise. This provides the country the effective means by which the world economy can be stabilized with global demand expansion, without spurring assumed demand-pull inflationary spirals. So, what is the Fed’s deal? Has Jerome Powell fallen prey to inflationary paranoia and hysteria for all the wrong reasons? Or is a “strong’ dollar a manifestation of a particular response to a policy choice that is more calculated and direct? By facilitating aggressive monetary austerity, the Federal Reserve is ensuring the US dollar is a safety asset to insulate the global rentier from cost-push-markup inflationary unpredictability. As such, expectations of future dollar depreciation arising from a return to loose monetary policy is, unfortunately, unlikely.
I hope I am wrong.
***Republished from the Monetary Policy Institute Blog***