David Gracey

David Gracey

David Gracey

Head of Foreign Exchange and Fixed Income Trading

Episode 8: The rise (and potential fall) of the USD as global reserve currency.

• It’s time to bring this series to an end and park this ship at its place in the harbour of history.

• The great recession had arrived with the collapse of Lehman’s (and others), and millions of people globally suddenly found themselves unemployed and facing a rather uncertain economic future.

• Lessons had been learned since the Great Depression of  1929-1930, and the US Government, and Federal Reserve, along with other Governments and Central Banks across the world stepped in to slow the carnage and right the ship.

• The US Government in particular needed to save a plethora of financial institutions that were threatening total collapse which posed a systemic risk to the global economy. The cumulative liabilities faced by these banks and insurance houses, along with Fannie and Freddie were unprecedented, threatening to usher in a new age of financial deflation and desolation. By 2008 the risks had become sovereign. Such was the nature of all this financial wizardry that countries like Greece, Italy Spain, Portugal, and Ireland, along with others faced complete economic ruin.

• And thus the US government was forced to bail out many of these “too big to fail” institutions.

• Hundreds of billions of USD were thrown at the problem, along with very steep interest rate cuts and a measure called QE, which is just a fancy term for printing cash. It all added up to trillions of USD, and the experiment was repeated across the world. Japan and Europe and China and, and and...

• It’s debatable whether the money went to the right places because much of it was used to speculate (again) into riskier assets, however, the collective measures did bear fruit and by 2009 there were signs of growth beginning to emerge and slowly US unemployment began to decline.

• In essence what had occurred was that Governments had assumed the liabilities incurred by these organizations. The debt burden was moved from private and institutional balance sheets and had become sovereign debt. And Central Bank printing presses were put into overdrive. Government and Central Bank balance sheets ballooned – a debt to be repaid at “some point” in the future, or perhaps more money to be printed thereby “monetizing” the debt incurred.

• For the next few years varying degrees of success were evident. The US, the first to react, quite quickly recovered, but Europe (and Asia) were less successful as they grappled with the fallout from the smaller nations.

• And then……COVID. 

• We all recall the impact of National shutdowns as empty streets and empty businesses were evident across the world. Again, it’s debatable whether these measures were required or indeed effective.

• More recently China adopted a zero covid approach and in effect “imprisoned” millions of its own citizens in their own homes.

• Once again the global economy teetered on the edge of oblivion, and once again the tried and tested response was rolled out.

• Cut rates, print cash, and flood the market with “liquidity”.

• Except this time the measures dwarfed even the amounts from 2008-2009.

• US national debt grew from roughly 23 TRILLION in 2020 to roughly 30.5 trillion USD as of today. And that’s not taking into account the Federal Reserve Banks balance sheet, which had also exploded by trillions.

• The end result …….INFLATION was back in a big way, across the world, laying the foundation for the next phase of global economic dynamics. It turns out that the Austrians (and the Zimbabweans, and the Germans, and the Romans, and the Greeks)  were correct all along. When you introduce fiat money into the system you get inflation. And as Paul Volcker understood, and modern central bankers are learning, inflation is an enemy that can only be defeated by raising rates and reducing the money supply. Even rapidly increasing technology cannot tame the inflation beast forever.

• And here we are today ….US inflation is at multi-decade highs, and the picture is similar across the world. 

• Tomorrow we will drop anchor on this sordid story (I will be going on leave after that) and summarize the quantum nominals that have been built up since the end of WW2, and also take a look at recent developments with regard to the USD’s status as a global payment mechanism.

• But today I leave you with one thing to ponder.

• When you have to fund your maxed out credit card and mortgage bond and car loan and overdraft at zero or 1%, you may feel just marginally uncomfortable. But when rates begin to rise, so do the levels of discomfort.

• The US government has more than 30 trillion USD of debt to refund...and 10 year yields have risen from below 1% 2 years ago, and today rates are around 3.2% and rising. 

• Japan has a debt to GDP ratio of around 250%....and they are very busy trying to keep a lid on yields (or….refunding costs). 

• All over the world National debt piles have grown exponentially over decades as Sovereigns have borrowed from the future to fix/fund periodic economic crisis. Borrowing costs will continue to rise.

• Little wonder then that markets are a tad shaky today.