EKIP– Expert Club for Economics and Politics A Different Opinion
The fundamental reason behind these imbalances is the monetary policy of the US central bank – the so-called Federal Reserve (Fed). Increasing the money supply, reducing interest rates and buying government debt lead to excessive consumption, inflation of bubbles and growth of government spending and debt.
The dollar and international trade
The medium of exchange in trade between residents of an economy is local money, but in international trade there has traditionally been one universal medium of exchange that is used in almost every transaction. Currently, this medium is the US dollar, which is involved in transactions between citizens of individual countries.
The dollar's role as a global currency increases the demand for dollars and thus its value in international currency markets. But the status of the US currency on a global scale has its own specific consequences. As a result of the widespread use of the dollar in international transactions, the US can finance its consumption without being threatened by currency depreciation, rising domestic prices, and the inability to repay its accumulated debts.
The Federal Reserve's monetary policy
Like any other trade, international trade is regulated by the price mechanism, where the price of one currency relative to others affects the trade volume of each country. At the same time, the price of a currency is determined by supply and demand.
If we look at the dynamics of the supply of the US dollar, we will find that from 1984 to 2013, the production of narrow money increased from 184 billion to 3 trillion dollars. For the period from 2008 to now alone, the amount of narrow money has increased by 2.2 trillion dollars. If we add to the monetary statistics others, such as the level of public and private debt (public debt amounts to 17 trillion dollars, and private debt to 40 trillion dollars), the level of lending, the level of interest rates and the balance of the US current account, we will find that there are a number of macroeconomic imbalances in the country.
Chart 1: Monetary base (narrow money)
What causes imbalances?
The fundamental reason behind these imbalances is the monetary policy of the US central bank – the so-called Federal Reserve (Fed). Increasing the money supply, reducing the interest rate and buying government debt lead to excessive consumption, inflation of bubbles and growth of government spending and debt. Usually, high rates of money supply inflation quickly result in higher prices, but in the case of the US, monetary expansion does not lead to sharp inflationary shocks, but to a smooth increase in the domestic price level (as measured and represented by the consumer price index) – Chart 2.
Chart 2: Consumer Price Index
Also, the Federal Reserve's loose monetary policy has had little effect on the price of the dollar in international currency markets (ignoring short-term volatility). Despite monetary inflation, the US's growing debt, and the country's worsening current account balance, the dollar's value has been relatively stable. This is due to its status as the world's reserve currency (and the depreciation of competing currencies).
Chart 3: Weighted average value of the US dollar against a basket of currencies of the US's major trading partners
The rise of the dollar
At the end of World War II, the monetary system of each country was in a deteriorated state, and monetary chaos reigned worldwide. The United States stood out as a creditor country, which had a significant gold reserve. Almost all other countries were bankrupt, and the main pre-war currencies were devalued. In order to restore order in trade and debt relations between countries, world leaders held discussion meetings in Bretton Woods, USA, in the period 1944 - 1947. Their idea was to create an international monetary order and a payment scheme derived from it, which would lead to economic growth, macroeconomic stability and low inflation.
The Bretton Woods Agreement of 1945 established a gold-dollar standard, which established a parity of 35 US dollars per troy ounce of gold and made the currency the main international means of payment. World trade began to be conducted almost exclusively in dollars, and it was thus adopted as a reserve currency, displacing gold from the treasuries of foreign central banks. This required the United States to meet the world's demand for dollars, but it also allowed the government to accumulate "deficits without tears." For the next almost three decades, the United States printed money, ran deficits, and exported inflation. Subsequently, central banks of other countries suspected that the Federal Reserve did not have enough gold to maintain convertibility between the growing dollar base and gold at the 1945 parity. They made requests to the Fed to convert their dollar reserves, but since the Fed did not have enough gold to fully satisfy any request at the old parity, it had to either revalue the exchange rate or refuse to convert. The choice fell on the latter. In 1971, President Richard Nixon closed the so-called “gold window.” This ended the Bretton Woods Agreement and ushered in the global paper money system.
What's coming up?
Producing money that has reserve currency status is of great benefit to the one who has such a privilege. The US currently has this privilege and it is completely understandable that it does not approve of other countries trying to trade outside of its established currency hegemony.
However, for some time now, China, Russia and Australia have been trading with each other not in dollars but in the currency of one of their respective trading partners. In addition, central banks have recently been increasing their gold reserves at the expense of their dollar reserves in an attempt to protect themselves from the export of inflation coming from Washington.
How will the fall of the dollar affect the US?
The dollar will likely not dominate forever, just as the pound sterling has not dominated forever. A continued decline in the share of dollar assets in central bank reserves and a decline in the currency’s use in international transactions will lower the value of the dollar. This will make American exports cheaper and imports more expensive, leading to a narrowing of the country’s trade deficit and a decline in consumption. Interest rates will also rise, making government debt less attractive.
When someone is interested in the dollar, it is useful to consider the consequences of the presentation that since 1971 a non-gold dollar has been used.
(Is the Non-Gold Dollar used in 2013 or not? The answer is "YES".)
Despite this useful exchange, the old, preserved from the time of the Gold Dollar, method of government is still used.
(In 2013, has the old, Gold Dollar-era way of governing been preserved? The answer is "YES".)
An answer is needed to the question: "Is the old, time-honored method of government with the Gold Dollar suitable or unsuitable for a Non-Gold Dollar?"
The correct answer is UNFIT. The same (i.e. this unfitness) is the cause of the current economic crisis.
Example: If this weakness were absent, the US would not have the debts available in 2013.
The presented conclusions are not complete, since the cause of the crisis is the current unprofitable way of government, and the other is a concomitant consequence of the development of a crisis.
The current crisis does not depend on the monetary policy of the US Central Bank, since the bank is a victim of the state's mistake and the cause of the crisis is not within its competence.
With respect to EKIP
Ivan Mitev