Tuesday, August 18, 2020

The Empire Will Strike Back: Dollar Supremacy Is the Fed's Imperial Mandate

Triffin's Paradox demands painful trade-offs to issue a reserve currency, and it demands the issuing central bank serve two competing audiences and markets.
Judging by the headlines and pundit chatter, the U.S. dollar is about to slide directly to zero. This sense of certitude is interesting, given that no empire prospered by devaluing its currency. Rather, devaluing the currency is a sure path to dissolution and collapse of the empire. This dynamic--devaluation leads to decline and collapse--is not exactly a secret.
So what all those proclaiming the death of the USD are saying is the Imperial Project is consciously choosing suicide, all to boost the U.S. stock market which is now little more than a signaling mechanism and a means of accelerating wealth inequality, as the billionaire class and the billionaire wannabe's in the top .01% are the primary winners as stocks reach new highs.
(Recall that the U.S. economy is best described as anything goes and winners take most.)
Taking it one step further, those predicting the collapse of the U.S. dollar are predicting that not only will the Empire choose suicide, so will the billionaires because what will their fortunes be worth if the USD goes to zero?
The USD-is-dead crowd (and it is a crowd) present the demise as ordained by some mysterious force, as if the Empire has no will or power to resist the inevitable slide to zero. The helpless giant can only watch as the Federal Reserve debauches the dollar to boost stocks and float the mountains of debt required to keep the U.S. economy from imploding.
The USD-is-dead crowd also seems to overlook the inconvenient fact that all the other issuers of fiat currency are busy debauching their currencies, too by the same mechanisms: the endless digital printing of new currency, distributed to already-insanely-wealthy financiers and corporations. (Debt-serfs can "save themselves" by borrowing more, heh.)
We get it: digitally printing trillions in excess of actual productivity eventually destroys the purchasing power of the over-issued currency. We also get the need to keep interest rates at near-zero so governments can fund endless trillions in stimulus and other giveaways--billions to the billionaires and a trickle of bread-and-circuses to the debt-serfs.
But this isn't the full list of dynamics in play. The demand for currency is based on a number of factors: yield (the interest rate paid by the issuing central bank) being one, the amount of global debt denominated in the currency being another and the demands of global trade being a third.
Ultimately, every currency is a derivative contract on the resilience, adaptability and innovative capacity of its economy. Every currency is a social construct that reflects the security of social contracts within the issuing economy, and the perceived security of the currency in the global marketplace.
The two are related, of course; but they also conflict. This is Triffin's Paradox, which I've discussed for years. In a nutshell, the paradox is every central bank with a global role as well as a domestic role serves two competing audiences: the domestic economy and the global economy.
There is no way to serve both. The domestic exporters want a weaker currency, while foreign owners want a stronger currency.
The dollar rises for the same reason anything else goes up: scarcity and demand. If the Fed over-issues USD, scarcity value falls. If non-domestic borrowers take loans denominated in USD, demand rises as this debt must be serviced and eventually paid off in USD.
The Fed's mandates that are constantly repeated are all about the domestic economy: maintaining control of inflation (Goldilocks: not too hot, not too cold) and domestic employment (if unemployment skyrockets and wages plummet, the debt-serfs might revolt).
But the Fed's one controlling mandate is to maintain USD global supremacy. Unbelievable as it is to the unwashed masses and the clueless punditry, the domestic economy (and the stock market) are sideshows compared to the primacy of the mandate to maintain USD supremacy as the one and only essential reserve currency.
To maintain global supremacy as the one essential reserve currency, the Fed must balance scarcity and demand. The pandemic illustrated the Fed's dual role and the conflicting demands of being America's central bank and the central bank of the global reserve currency.
To keep the domestic economy and stock market from imploding, the Fed digitally printed $3 trillion and unleashed it as flood waters, raising all boats to some degree.
As the global central bank, it opened stupendous lines of credit, repo's and currency swaps with other central banks to exceed global demand for USD, lest a soaring USD snuff the global stock market rally, a rally the Fed saw as the one essential signaling mechanism that the global economy was recovering.
This over-supply of USD was calculated to suppress the dollar's value by eliminating scarcity--it didn't affect demand which continues unabated.
Now that this one-off emergency response has done its job, the Fed has to switch back to defending the dollar's value. The clueless punditry is absolutely certain that the Fed is going to drive bond yields to zero or even below. The reason why this is clueless is the punditry are only looking at the secondary mandates of the Fed and ignoring its Prime Directive: maintain USD supremacy.
Pushing rates negative and flooding the global economy with USD is a sure way to reduce scarcity and demand, so those are not going to happen.
Rather, U.S. yields will start rising--maybe in fits and starts, but they will start moving up longer term. And the Fed isn't going to over-supply the global economy with dollars; they're going to start limiting the excess issuance, not publicly but behind closed doors.
Scarcity and demand will both rise, dragging the dollar higher. Don't bother asking why or how, just watch the yields click higher despite every financial pundit pounding the table for zero or even negative yields. Yields may dip and weave from month to month, but watch the trend.
Just as all currency is a social construct, trust in the liquidity and transparency of the currency's market value is the essential ingredient in a currency's valuation. The only way to establish a trustworthy measure of liquidity and transparency is to allow the currency to float freely on the global FX exchange. Issuing nations who want to control the value are intrinsically untrustworthy as no holder of the currency can be sure the value won't be manipulated to serve the issuer's political agenda.
You can't control the global value of your currency and have a reserve currency. This is where the punditry are again clueless. China does not seem particularly keen to relinquish control of its currency (RMB) to market forces. Thus it maintains a peg to the USD to retain control of the RMB's value on global exchanges.
The demand for RMB is thus limited. The RMB has about a 2% share of global trade and an equally minimal role in global debt denominated in RMB. To increase the global role of the RMB, China will have to end the USD peg and let the RMB and its sovereign bonds float freely and be priced by the market.
In other words, they'll have to relinquish the direct control they currently have over the RMB's valuation.
Triffin's Paradox demands painful trade-offs to issue a reserve currency, and it demands the issuing central bank serve two competing audiences and markets. This is why some economists believe the U.S. would be better served by giving up the reserve currency and thus be free to serve only the domestic economy.
This makes very good sense, but it overlooks one little thing: America's global empire. The Imperial Project requires USD supremacy, period. Nothing less will do, and so that is the Fed's single Prime Directive.
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