7/29/2019 World Reserve Currency - A bliss disguised as blessing

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World Reserve Currency Bliss disguised as blessingBy Asif Punjwani January 1, 2013

The US dollar has remained the world reserve currency since the end of WW2. Dollar

had fractional gold-backing, forcing an expansionary limit to its money supply. Dollarwas as good as Gold, just more liquid. Every country chose Dollar Treasury bills overholding Gold, as holding T-Bills paid interest. Gold didnt.

United States starting building its Military Industrial Complex and took on adventureslike the Korean and the Vietnam War running huge fiscal and trade deficits puttingpressure on dollars fixed peg to Gold. In 1971, Nixon was forced to close the Goldwindow. Dollar was no longer as good as Gold, but it had already become a widely usedreserve currency and the most liquid trading asset. Other Central Banks were left holdingthe dollar denominated treasury bills. They couldnt simply sell them and buy Gold

because there just wasnt enough Gold in the world to buy with those TBills. Or in otherwords, those Tbills werent worth what the exchange rate was telling them.

Since 1973, the US Fed got a blank check from the foreign Central Banks to expand itsmoney supply, via reserves and commercial lending. Gold was no longer the bottleneck.Currencies were floated freely against each other.Gold shot up from $35 to $615 beforethe prices stabilize(See Graph). The markets had spoken and the Emperor was declarednaked.

But the world continued to accept US TBills for its exports to US since Oil was sold indollar. There was a huge demand for TBills in the International market to accommodate

the growing international trade. It was necessary for the US to run hugetrade deficits,and lateraccounts deficits, to producemore and more IOUs- or so the story goes.

With closing for the Gold window, the game had now been changed. Credit creation, justli ke money creation, was now counted in GDP growth j ust like any industri al growth.In measuring GDP growth, there was no difference between manufacturing machines andmanufacturing credit/debt. In reality, real goods make societies rich. Debt makes societiespoor via interest payments. I nterest payments are not profi ts but mere transfer ofpayments. Markets compete for capital and whichever sector is most efficient inproducing profits, would see capital flow in its coffers. Industries producing consumerstaples, construction material and machinery see their cost of raw material go up due to

money dilution via federal debt monetization and private credit creation. Meanwhile thecommercial banks see their business grow as financing needs of businesses andindividuals grow due to the very inflation private credit creates.Profits for banks rise butthose of the Non-financial economy falls.

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It should be no surprise to any policy-maker that the reason why the United States lost itsmanufacturing base since the 1970s was due to currency debasement which was beingentertained by a rapidly growing financial sector. Electronics and appliancemanufacturing was being replaced by financial structured products and electronic credit

creation. After all, the cost of producing commercial paper is far less than the cost ofproducing real goods.

There would have had been a reckoning to all these financial shenanigans if the Dollarwas not a reserve currency. There wouldnt have been a need for foreign central banks tobuy US TBills. The bond markets would have reacted, interest rates would have soaredand the currency would have devalued. But for the bond market to react, the capital has toflow somewhere and that somewhere only exists in non-dollar denominated capitalmarkets which are nowhere as deep/liquid. The role of the derivatives markets cannot beoverstated here either. From TED spreads, SWAPS and FRAsthese instruments havecornered the global bond vigilantes.

This trend of driving real economic businesses out of business and the growth of financialservice sector would continue to create income disparity in the US for years to come. Aworld reserve currency, which was supposed to bring prosperity to the United States andstability to the rest of the world, has brought social inequality, income disparity and apolice state to Americans and the rest of the world.

The writer is a Texas-based equity, bonds and derivatives trader. Reach him via Twitter

@AsifAmeer_AP