The Daily update - Not Just Rate Changes At The Fed

The expected 25 basis point (or even 50 basis point) rate cut expected later may not be the largest change today for the Federal Reserve. A Senate bill also due today could soon force a third mandate (or fourth if you include financial crisis mitigation) on the Fed: one requiring them to balance the US current account within five years. The Federal Reserve’s existing official mandates are, of course, price stability and full employment.

The greenback’s status as the global reserve currency has very many advantages, but the current focus seems to be on apparent risks and excesses. Not only is there the perpetual tendency towards a trade deficit over the long term, but short term speculative investment can drive up dollar volatility and, as some would see it, help overinflate its value. This new mandate could usher in new powers for the Fed to tax foreign speculation and investment in US assets; these “market access charges” would be aimed at curtailing short term speculation but would likely also have some impact on longer-term FDI.

Looking at the stock and bond markets, in 2018 foreign investors bought over $21 trillion in US securities. Furthermore, foreign holdings of Benjamin Franklins has trended from 30% of circulation in 1980 to 80% now; an even starker illustration when one realises that $100 bills in circulation have more than doubled since the Global Financial Crisis and recently surpasses the total number of dollar bills for the first time.

Over the past 15 years, the US deficit has fallen from over 6% of GDP to now around just 2.5% but this has already involved drastic protectionist reforms to trade policies. Now, there seem to be increasing signs of headwinds against Trump's phantasmal ideal of being the bearer of the global reserve currency without the national debt to facilitate it; China’s stance has become ever more defensive, and to top this off recent data shows that China has been running an increasing trade surplus with the US and globally - a combination of weakening Chinese imports and growing exports in markets other than with the US. According to Brad Setser of the Council on Foreign Relations, “China's manufacturing surplus with countries not-governed by Donald J. Trump is up about $100 billion over the last 12 months.”

If the dollar is indeed overvalued, with the IMF recently projecting it is by 6-12%, then such a charge on foreign investors may be a more efficient way to achieve the desired devaluation, than tariffs and beggar-thy-neighbour policy rates alone. With trade war retaliation and further easing from other central banks across the globe, the US has a unique strength in enacting foreign “market access charges”, whereas the same policy in other less internationalised markets would likely be less effective at placing weakening pressure on their currency. However, the inevitable side-effect of such a policy would be further volatility, which is not really what teetering markets need more of right now.

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