Gone Global: the U.S. Fed as Global Banker of Last Resort

I’m doing some reading on current activities of the US Federal Reserve in light of their classic mandate to coordinate inflation and unemployment in the United States. I decided to write a post on the changing role of the Fed since the last recession more to clarify my understanding than anything else. If it seems a bit arcane, I hope you understand.

The US Fed today does for global finance what the Bank of England used to do in the hey days of the 18th and early to mid 19th centuries: backstopping a huge amount of the world’s trade and commerce. After World War 2 and Bretton Woods, when the US Dollar became the world’s reserve currency, the Fed essentially became the world’s bank. Of course it was not explicitly so, there were still the IMF and World Bank and several regional central banks who did the bulk of the world’s actual monetary policy, but as far as international trade was concerned, the US Fed held the keys to maintain both the domestic reserve of dollars for its own country, but the international reserves of dollars for everyone else in the world. And when the Dollar was decoupled from gold in 1971 (to the consternation of conspiracy theorists all over), the US dollar essentially became gold, except that the Fed this time had the ability to supply it anytime, without limits. That has it’s uses, but that’s not today’s discussion.

Now, since the 70s, the Fed’s central place in global finance was not as binding or apparent in its daily activities until this last recession. Having lowered interest rates to zero and held it there over the last few years, the Fed (and other central banks) not only filled the market with liquidity, but also pushed a lot of that capital into emerging markets in search of yield. So, post recession, the emerging markets, which had been growing with the globalization of finance even before 2008, went fully parabolic, fueling a rise in commodity prices, capital inflows, investments and more across Africa, Asia and Latin America.

However, as the US recovery has gained steam fueled by Corporate profits (many of them from emerging markets), real estate recovery and retail, the expectation that the Fed would raise rates caused a huge amount of capital to leave the emerging markets to come back to the safety of the US markets. Between June and September (when analysts expected the Fed to raise rates) an estimated $1 trillion in capital drained out of emerging markets. Add to that the crash in commodity prices, and countries like Nigeria, Brazil, China and everyone in between are suddenly waking up to the reality of their situation and dependence on the Fed.

The Fed on the other hand, also realized the havoc raising rates was about to wreck on EMs, and probably worried about a new global recession, has decided not to raise rates anymore, until either December or next year. So in essence, everyone in the world now understands what the deal is: the Fed is everyone’s Fed now. Americans who are arguing for a raise, insisting that the IMF and other global bodies should not have to dictate American policy are missing the point. It’s not American policy that the Fed is making anymore, even if the bank is ostensibly the United States Federal Reserve its wings have come full circle. It’s also why I think while China’s AIIB will make a dent in the global finance world, it’s not going to be a big one. There’s just no way the Renminbi is going to replace the dollar anytime soon, China can only hope. Neither will any sort of dealing insulate China’s client states from the reality of US financial power. It’s not happening.

Add the new agreement between US and the European Union to streamline policies and regulations around agriculture, finance, industry and trade, there’s a growing circle of universalism, led by American money. It’s been their world, and if it seems as if the U.S. as a nation is in decline, it’s only because the organs or instruments of it’s power are globalizing.

It’s going to be an interesting future, and I’m all eyes to see how this goes.

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