*Looking at the US Dollar and current Quantitive Easing/Fiscal Stimulus in the United States*
In this blog post I am going to talk to you about the U.S. Dollar currency, the current action taken by the US Fed to combat the effects of the Coronavirus on the economy and why I think a lot of traders/investors are way too confident on a collapse of the Dollar.
We have all seen the abundance of memes about J Powell and his money printer on social media recently and although it is funny, there is a lot more to the macroeconomics of the current situation than first meets the eye. Let’s start by taking a looking at the stimulus packages offered globally to compare.
As you can see, the United States is not the biggest spender in response to the Covid-19 pandemic if you measure the dollar value of stimulus as a percentage of the countries GDP. Japan are winning this contest having spent over 62% more than the U.S. on stimulus to combat the economic implications of the coronavirus.
The total U.S. stimulus package is only the largest in a purely financial sense (a monetary value), it is not when you display it as a percentage of its economic strength which is a much better way of showing this information. If an economy has a greater ability to service its debt then it can afford to leverage itself more.
What does the US stimulus package consist of?
Let’s look at what the Fed have spent money on so far to combat the effects of the coronavirus pandemic.
- $8.3 billion – Healthcare organisations and coronavirus treatment research.
- $100 billion – Free testing, paid emergency leave and unemployment and Medicaid funding.
- $2.2 trillion – CARES act included the individual stimulus checks, $350bn PPP, $500bn corporate bailout fund, expanded unemployment payments and aid for healthcare and hospitals and $150bn for state and local governments.
- $484 billion – Interim CARES act included $310bn extra PPP, $75bn for healthcare providers and $25bn for coronavirus testing.
The table above shows the monetary and fiscal policies of 7 major central banks in response to the coronavirus pandemic as of mid April 2020.
Notice how every central bank cut interest rates. This is important.
One of the main arguments I have seen online for why the U.S. economy and the dollar currency is heading towards a great crash is because they are cutting rates and printing too much money which is going to lead to hyperinflation and Dollar weakness. The effects of any action are diminished if everyone else is also doing the same.
If every central bank is cutting rates and “printing money” then the effects on both inflation and monetary/fiscal policy is vastly reduced.
How many new U.S. Dollars have actually been printed?
Not all of the money required to provide the fiscal stimulus listed above comes from printing. The world has been swimming in savings in recent times which is one reason why interest rates have been low for some time before the coronavirus hit. Also, in times of economic uncertainty money flows out of stocks, corporate debt and other riskier investments and in to treasury debt like the U.S. This means it is easier for the Fed to borrow money without paying higher interest rates.
By cutting interest rates, the Fed allows banks to pay less for borrowed funds so they can then afford to lend more, thus stimulating the markets more.
When the Fed create more dollars through Quantitive Easing they don’t actually print vast quantities of cash dollars. This would be useless in current markets because there is no way to get that cash in to the public domain and in circulation quickly. Instead they are simply adding credit to their member banks deposits.
The total money supply being used to combat the coronavirus pandemic comes from money issued by central banks and money created by commercial banks with the latter making up the majority. The “printing” of new money makes up only a small portion of total supply.
Fun Fact! Helicopter Money is the term used to describe an unconventional form of monetary policy where central banks make payments directly to individuals. Much like as if they were to literally throw money out of a helicopter at the public standing below. The U.S. actually did this in 2020 with their $1200 stimulus checks but this was not “helicopter money”. The funds used for the stimulus checks DID NOT come from central bank money printing, it was financed by the state as debt.
It is also important to note that the Fed can “unprint” money just as quickly as it “prints” money. This can be used to dry up liquidity by raising central bank interest rates, and slowing economic growth and inflation.
The Fed are saving companies without spending.
A lot of the fiscal stimulus is through implied spending and increasing investor confidence which is leading to increased liquidity in the markets. Promising to buy debt from the markets instead of actually being required to do so. For example, the corporate debt purchasing programme announced by the Fed didn’t actually lead to them buying a lot of corporate debt but instead saying they will if necessary. This reinstall confidence in the markets and allows private investors to more confidently purchase the debt themselves.
This is proven with the case of Boeing (BOE). Boeing went to the government and asked for a $60 billion bailout to save itself and its suppliers. This bailout would have come with strict rules on their future operations included dividend payments, staff salaries and bonuses. Instead the Fed used the “seemingly” infinite balance sheet to announce they intend to purchase corporate bonds and overnight the corporate debt market was flooded with liquidity.
This then helped Boeing to almost immediately raise $25 billion from private investors with lower restrictions and better terms than if the Fed would have bailed them out. A link to the full article is below.
Guaranteeing debt in the U.S. economy is a good thing. It makes U.S. debt safer, in turn increasing its attractiveness to investors without actually requiring the US Fed to spend any of its own money on the debt. The Fed are NOT buying all debt, they are saying the will if they have to.
Current USD strength.
Looking at the Bloomberg dollar index chart (BBDXY) shown above, it is clear to see that the dollar is still proving to be significantly sturdy when compared against a basket of the major currencies. This is despite all of the fiscal and monetary stimulus already announced. For reference, the BBDXY index was created in 2004 with a starting value of 1000.
Important! I am using the BBDXY chart and NOT the standard DXY to gauge the strength of the U.S. Dollar for multiple reasons. I explained my dislike for the DXY in a previous blog post last week which can be found by clicking on the link below.
It is also fairly safe to say that the Fed has thrown everything they have at combating the effects of the coronavirus so it could be said that there is no more they can do. This in turn means there is very little left to weaken the dollar further in regards to QE. You will notice on the BBDXY chart above that towards the beginning of the pandemic, USD did initially drop in value on the initial announcements of seemingly “infinite QE” but this soon levelled out.
You can use the BBDXY to determine where the strength of the dollar is currently vs previous dates in time, for example after the 2008 financial crisis and the 2018 global indices sell off.
The chart above shows the BBDXY chart from creation through to 2018. As you can see, ING (a well respected institution) were predicting US dollar weakness in to 2020 yet as we can see on the previous chart, the Dollar continued to climb back up to all time highs for the index. Betting against the U.S. Dollar is not a new thing and many have been proven wrong.
You can also use this chart to see that Dollar has a long way to fall before it even approaches all time lows as seen prior to the 2008 financial crisis. And look what happened that time – the U.S. Dollar gained in strength against a basket of other foreign currencies.
Is there is risk of hyperinflation?
The short answer is no. Hyperinflation is actually quite difficult to create and is very unusual. As mentioned early, the supply of money from “printing” is only a small portion of total money supply. Much like after the 2008 financial crisis, there was strong Quantitive Easing and people were saying there would be hyperinflation but there never was.
Banking regulations that limit money supply from commercial bank lending counteracted any new supply of money from central banks, thus meaning the total supply of money grew slowly and avoiding hyperinflation. This is likely to happen the same again after coronavirus pandemic.
USD is the global reserve currency.
The data below shows that the USD was involved in 88% of all FX currency transactions in 2019. This shows how large the level of demand for dollars is as a result of it being the global reserve and peoples views on it being a reliable and consistent currency. The second most traded currency in the world was the Euro which was involved in 32% of FX transactions.
For another currency to take the reins as global reserve it would need to make huge leaps in terms of global usage in a short amount of time.
Remember, even if the dollar might weaken in strength, it does not mean it cannot still be used as the global reserve currency.
I personally cannot see any viable alternatives to the USD for use as the global reserve currency. One popular suggestion is an asian currency such as the Chinese Yuan or the Japanese Yen but there are a few key reasons why this is not likely.
Firstly, China is still not highly trusted by the western world and its dictator state causes concerns for many. The Yuan is also not a freely convertible currency as a method for the Chinese government to control the exchange rate. This is shown in the data above with the Yuan (CNY) being the 9th traded FX currency in 2019 and Hong Kong makes up over 3/4 of Yuan international payments.
Japan has the highest central bank debt to GDP ratio of any country in the world at a ratio of 198%*. For comparison, Greece is second with a ratio of 194%* and the United States has a ratio of 90.4%*. Usage of the Japanese Yen in 2019 FX transactions actually decreased in 2019 compared to 2016 showing a shift in the opposite direction compared to the Euro and US dollar.
*Data from IMF as of December 2018. https://www.imf.org/external/datamapper/CG_DEBT_GDP@GDD/CHN/FRA/DEU/ITA/JPN/GBR/USA
The other more radical suggestion, which is still gaining traction, is that Bitcoin or at least another major Cryptocurrency will become global reserve currency. This is not a viable alternative in my opinion for 2 main reasons.
The first is that it cryptocurrency is way too volatile to be useful for businesses and industries to actively use it as a payment. Volatility is only potentially profitable for the trading/finance industry, for everyone else it costs money to manage and hedge, which is an unnecessary expenditure. Until cryptocurrency is adopted by all, there will always be a need to convert it back to a FIAT currency and that is where your problem lies.
Cryptocurrency is also still unknown in terms of usage and its scalability. Where as the dollar and other FIAT currency has proven its ability to be scaled and used globally.
You can check out my thoughts on cryptocurrency in my previous blog post. Click on the link below to read it now.
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