Dollar strength is almost entirely due to the level of dollar-denominated debt in the global financial system, much of it not involving US entities nor under Fed regulation.
The world is being strangled by designating so much of its debt in “dollars”, as Fed dollars get scarce.. That also explains why countries with massive trade surpluses are seeing their currencies plunge against the dollar. Dollar-denominated debt vastly exceeds trade flows because trade surpluses become dollar-reserves and the reserves then get multiplied into dollar liabilities.
Source: TW 202210
It is extremely important that thinking people grasp the basics of our modern global monetary system. What you do not know can hurt you. Here is a very basic outline.
- Nations export to the US and receive dollars.
- Nations export to nations that export to US.
- After step 2, dollars start circulating globally and don’t need to come back to the US to claim goods/services or assets.
- Global banks start creating more dollar assets and liabilities, based on the “real dollars” that arose in trade with the US. Very important step.
- After many years of step 4, total “global dollar” bank balance sheets, outside the jurisdiction of the Fed, vastly exceed the sum of US trade deficits i.e, “real dollars”.
- The Fed does not regulate those “global dollar” balances but its actions have strong influence.
- When Fed keeps interest rates low and does Quantitative Easing (QE or money printing), “real dollars” become more easily available and “global dollar” balances go up faster. Party time for the world. Seemingly everyone prospers, with the world awash in dollars.
- Some of those rising “global dollar” balances flow back to the US, invested in asset markets like equity and real estate. Bubbles arise.
- This feels like prosperity for the US too, because of growing “wealth” - asset inflation.
- US consumer prices start to rise.
- When consumer prices start to rise, the Fed acts and raises interest rates, reduces QE, starts Quantitative Tightening (QT). Trouble starts.
- Global dollar balances reflect the tighter “real Fed dollar” situation. Interest rates go up. Borrowers need dollars to repay.
- Currencies drop against the dollar because global-dollar-indebted borrowers scramble for dollars.
- US equity and asset markets drop because the mad rush for “global dollars” by borrowers means they sell US assets to raise “real dollars”.
- US asset markets break.
- Rising “global dollar” distress has fed back into US market distress, forcing the Fed to act, which means lower interest rates and restart money printing (QE).
- “Real dollars” become cheaper and more readily available, so “global dollar” balances go up again. Party!
In this cycle, we are almost at step 15 now (“US markets break”) and the widespread expectation is that the Fed will “pivot” (i.e step 16). Due to these repeated cycles, “global dollar” balances are hyper massive, and exceed US GDP/asset values. Repeated cycles and the scramble for “real dollars” in step 12-13 means the world badly needs more dollars and so wants to export to the US. The US progressively loses its manufacturing and industrial base due to the flood of imports set off by this scramble for dollars.
Conclusions.
The global monetary system is fundamentally unsound and prone to serious recurring crises. What comes next? We can expect new crises to arrive faster and get bigger than previous crises. The system becomes more and more unstable. We have to be prepared.