JOHN MASON: Strong Dollar, Weak Yuan, and the Fed

John on how the Fed's policy rate hikes increase pressure on Emerging Markets

Strong Dollar, Weak Yuan, and the Fed

Over the past couple of months the Federal Reserve has faced growing pressure from emerging market countries due to its steady increase in its policy rate of interest and the reduction in the size of its securities portfolio.

Jerome Powell, Chairman of the Board of Governors of the Federal Reserve System has been very forceful in his statements about the Fed’s efforts to “normalize” interest rates in the United States and to get back to a “more normal” size for its securities portfolio.

The signals are that the Fed will patiently continue this process well into 2019.

One problem that has arisen due to this process is that the value of the US dollar has risen in foreign exchange markets and this has put undue pressure on emerging market countries.

The country most severly hurt by these events has been Argentina who was actually forced to seek help from the International Monetary Fund.

However, the impact of the stronger dollar is causing especial concern when it comes to the decline in the value of the Chinese yuan.

The strength in the dollar across the world began in early February.

In terms of the Chinese yuan, the US dollar reached a low on February 7, 2018, when one dollar could only buy 6.2676 yuan.

At the market close on Monday, June 25, the dollar could buy 6.5448 yuan, a 4.4 percent rise from the earlier date.

The most recent decline in the value of the yuan came after a Sunday announcement by China’s central bank that it was freeing up more than $100 billion in the banking system in order to boost bank lending and spur on a slowing economic growth rate.

This just added on to the weakness of the yuan following the earlier moves of the Federal Reserve mentioned above.

The concern?

The concern is that further depreciation of the yuan against the US dollar will increase trade tensions between Washington, D. C. and Beijing.

Furthermore, many economists and others expect to see the value of the yuan fall even further against the US dollar.

Mr. Powell and the Federal Reserve are very intent on pursuing the current thrust of monetary policy in the United States and with a weak or weakening Chinese economy the fear is that a sustained fall in China’s currency could exacerbate outflows of capital from China.

This is a very sensitive subject for the Chinese. It is one of the last things the Chinese want.

And, this situation, I believe, put focus back upon the Federal Reserve.

The Federal Reserve is, whether it likes it or not, the de facto, central bank of the world. What the Fed does impacts many and so plays that role without ever asking for it.

Of course, that is a position of great power, something the Fed and the United States does enjoy most of the time. However, there are other times…like the one that we are in…where this responsibility can be a real pain.

The Federal Reserve is pursuing the goals set up for it by the US Congress…that are solely domestic in nature.

But, how can the Fed operate optimally when it comes to creating the right policy for the domestic United States, when it faces situations like the one it now faces where what it does can have major impacts on other countries throughout the world?

And, especially in China, where what it does can add pressure to other things going on…like tariff wars.

It seems as if, over the past ten to fifteen years, the Federal Reserve has become more and more involved with what is going on in other countries and has had to play…from time-to-time…and important role in what is going on elsewhere.

Furthermore, it seems to me, that situations like these are going to become more and more important in future years.

The interesting thing is that more and more people talk about how more and more countries are leaning more and more to the populist side of things and, as a consequence, more and more countries are becoming “nationalistic” in their actions, which, of course, work against globalization.

The fact that the Federal Reserve is facing international pressures like it is relative to China…and to Argentina…and to others…indicates how fluid world financial markets are at this time and how information flows, almost unconstrained, all over the globe. The changes in the world financial system of the past sixty years or so are mind-boggling.

The changes in global trade have also been mind-boggling.

My point is that what the Federal Reserve is going through right now is indicative of how networked the whole world is and that this networking will dominate the future, regardless of whether or not nations try to control their own destiny.

How the Federal Reserve meets this challenge in the future will be very interesting to observe.

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