The Fed Normalizes Money Printing, Marking the Dollar's Eventual Demise

 | Jun 15, 2017 | 8:00 AM EDT
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The Federal Reserve's monetary policy meeting yielded few surprises for the markets. As expected, the Fed raised interest rates by another quarter of a percentage point to between 1% and 1.25%. As expected, it started to lay out plans to "normalize" its bloated balance sheet.

At the same time, the world's most important central bank also normalized money printing -- a policy instrument that almost a decade ago was introduced as an extraordinary, emergency, one-off response to the huge credit crunch that threatened to engulf the world economy.

On Wednesday June 14, while trying to make it look like it clearly was telegraphing its intentions to cut its $4.2 trillion in holdings of Treasury bonds and mortgage-backed securities, the Fed left some bits of the process intentionally ambiguous.

In details about its plans to wind down quantitative easing, the Fed said it initially would set a cap of $6 billion a month above which it will reinvest proceeds from the repayment of principal for Treasury bonds under its asset purchases program. The cap will be raised by $6 billion every three months until it reaches $30 billion per month.

For agency debt and mortgage-backed securities, the monthly cap will be $4 billion initially, eventually rising to $20 billion a month.

If this sounds very clear to you, read the two paragraphs below:

"The Committee also anticipates that the caps will remain in place once they reach their respective maximums so that the Federal Reserve's securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively."

And

"The Committee affirms that changing the target range for the federal funds rate is its primary means of adjusting the stance of monetary policy. However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee's target for the federal funds rate. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate."

In other words, asset purchases are here to stay, and the central bank in charge of the world's reserve currency has just told us it feels free to implement them at any time it wants.

The most unsettling thing about this approach is that, while people unhappy about a government's economic policy can vote that government out of power at the next election, there is nothing they can do if they are unhappy with the central bank's policy.

If money printing affects you in any way -- for instance, by weakening the currency, thus making imports more expensive, inflating house prices beyond your reach, distorting capital allocation toward speculative rather than productive investment, or by imposing a tax on your cash savings in the form of negative real interest rates -- there is nothing you can do about it.

This will work for the Fed for a while because of the dollar's "exorbitant privilege" as the world reserve currency. The U.S. simply can export its problems by increasing or reducing the supply or dollars, and the world will just have to take it.

Over the long term, however, this could be the dollar's undoing. The greenback is still seen as the safest store of value among all other currencies out there, but abusing this status will end up undermining it.

The euro (EUR) has its flaws, but people still believe in it enough to have made it the second global reserve currency. The British pound (GBP) may be wobbly now, but it is liquid enough for its status as an alternative reserve currency to rise. The same goes for the Japanese yen (JPY); unlike the Chinese yuan (CNY), which is still tightly controlled by the People's Bank of China, the yen is freely floating and liquid.

Other currencies could step up, too -- the Canadian dollar (CAD), the Swiss franc (CHF), the Australian dollar (AUD) or even the New Zealand dollar (NZD), not to mention deep and liquid emerging market currencies such as the Brazilian real (BRL) or Mexican peso (MXN).

The number of options for those seeking safe havens in times of trouble is increasing with the advent of cryptocurrencies such as the bitcoin. True, for the moment these are plagued by instances of hacking of exchanges, but there will come a time when they will be secure enough to be adopted by the wider public.

Other options, such as precious metals, also could rise up to become an attractive alternative to the dollar. The Federal Reserve's decision to normalize money printing could be the first step toward the U.S. currency's demise.

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