Home > No USD Debasement Taking Place Despite Trending Lower

No USD Debasement Taking Place Despite Trending Lower

August 27, 2020 By Mircea Vasiu

One of the strongest fears investors have is for a central bank to debase its currency. Debasement in the monetary policy world refers to an abrupt decline in the value of a currency. So abrupt, it dilutes the value of various investments denominated in that currency. 

The Fed in the United States recently sparked such fears. And, for a good reason. The USD declined across the FX dashboard, with little or no bounce whatsoever.

The problem is that, while the USD is the world’s reserve currency and most of the world’s debt is denominated in USD, other currencies appreciate. Hence, while a lower USD is good for the U.S. product’s competitiveness, it hurts other countries’ exports.

How Much is Too Much?

The fear is that the U.S. election will trigger a new round of USD flooding the markets. The Congress already considers a new round of fiscal stimulus and that will widen the M2 gap between the United States and the rest of the world further. If that is the case, the current consolidation on the USD is nothing but a consolidation, and a new leg lower begins.

Yet if we look at the USD’s share in central banks’ reserve ratios, we see that the world has no alternative to the USD as a reserve currency. Sure, the ratio declined in the last two decades, but the world still trusts the USD and its ability to preserve value. Hence, debasement theories are out of context as long as the dollar’s share in the world’s central banks reserves remains relatively stable.

So, where is all the USD that the Fed prints? A big chunk of it sits in the Treasury’s account. If you have more of a good but keep it stored away, the price of it remains relatively stable. Think of the diamond industry as an example.

The Fed’s task moving forward is to find a way to keep the USD relatively stable while printing continues until the pandemic goes away. Judging by how the Fed did in the previous crisis, this is by far the most challenging crisis it ever encountered.

Today’s Jackson Hole’s opening remarks by Jay Powell will offer a glimpse into what the Fed plans to do in the upcoming future. With the USD on the brinks of further declines, the Fed must be careful what tone it uses.