Can The Federal Reserve Ignore Currency Disruptions Throughout The World?

Summary

• Fed Chair Jerome Powell, in recent speeches and interviews, has tried to clarify how he believes monetary policy should be set, but he has carefully avoided discussing international factors.
• But whether it likes it or not, the Federal Reserve impacts the world through what it does and can create "unintended consequences" globally, even in the emerging market nations.
• This problem will become a growing issue for Mr. Powell and the Federal Reserve because it is not going to go away, and will, in fact, become even more consequential.

In his speech at the Federal Reserve’s conference at Jackson Hole, Wyoming, last week, Fed Chairman Jerome Powell laid out his vision of how he believed monetary policy should be conducted.

Let it be noted that Mr. Powell said little or nothing about how international factors should be incorporated into the Fed’s decision making. In fact, since Mr. Powell has become the Fed’s Board Chair, he has tended to put aside any discussion of issues that are not domestic in nature. This is a subject he just does not seem to want to deal with.

Yet, as I have mentioned in other Seeking Alpha posts, in many respects, the Federal Reserve is de facto the central bank in the world. And I am not the only analyst in the world to think that this is the case. For example, Joachim Fels, managing director and global economic advisor at Pimco in Newport Beach, California, writes in the Financial Times that “the Fed is not only the US central bank, but also the pacemaker for the global credit cycle.”

The Federal Reserve plays an important role in the liquidity of many nations throughout the world. This became critically apparent during the Great Recession and after, as Ben Bernanke and the Federal Reserve played a crucial role in the solvency of many banking systems of many nations. Mr. Bernanke writes about this activity in his memoir of that time, “The Courage to Act.”

Even today, the Federal Reserve has almost $232 billion in reverse repurchase agreements, with “Foreign official and international accounts” as a liability on its balance sheet. Note that this line item accounted for less than $100 billion in October 2014 and rose steadily from then, until it reached the $245 billion level in February 2016. It has remained in the $230-250 billion range ever since.

Furthermore, at the end of July, commercial banks in the United States had more than $130 billion in “net deposits due to foreign offices” or offshore deposits around the world on their balance sheets. These are funds that have flowed from the cash balances that (primarily) large US commercial banks have at the Federal Reserve to foreign offices placed offshore to help beef them up... that is, provide their foreign offices with liquidity.

In June of this year, the total was $192 billion. In October 2014, this account peaked at just below $750 billion. These are ways that US dollar liquidity finds its way from the Federal Reserve and the US commercial banking system into banking accounts throughout the world. Every day, the Fed is playing a part in the US dollar liquidity in the world.

Whether or not Mr. Powell says anything about it, the Federal Reserve is engaged in the health of the world banking system, and its decisions do play a role in global banking and financial systems. More and more I believe Mr. Powell and the Federal Reserve will be playing some kind of role in many situations that rise up around the world.

And so we see the Federal Reserve continuing on its path of raising its policy rate of interest with, right now, five more moves scheduled before the end of 2019. We further see that the interest rates increases result in a stronger US dollar.

A stronger dollar puts pressure on the currencies of emerging nations, for example, the lira of Turkey and the peso of Argentina. These are nations that have economic problems, have too much debt outstanding - a lot of it denominated in US dollars - and governments that have not done what their countries have needed.

Turkey’s lira, at the close of business on Thursday, it cost 0.1476 Lira to buy one US dollar. Earlier in July, it was over 0.2100 Lira to buy a dollar. In July 2017, it was over 0.2800 per dollar. And the government of Turkey is doing little or nothing to maintain the value of the lira - this just makes a bad situation worse.

In terms of the Argentine peso, when the market closed today, one dollar could purchase 38.7340 pesos. One week ago, on August 23, one dollar could purchase 30.4670 pesos. On July 30, one dollar could purchase 27.2482 pesos. And at the end of 2017, one dollar could only purchase around 18.0000 pesos.

Yesterday, the central bank of Argentina raised its policy rate to 60 percent, up from 45 percent. Furthermore, the government asked for an advance on its “bailout package” from the International Monetary Fund to help the country through the upcoming budget crisis.

All this “comes amid mounting jitters across multiple emerging markets, as a strengthening dollar buoyed by a fast-growing US economy and a Federal Reserve committed to a series of rate increases has raised questions over whether companies and governments in the developing world will be able to pay off their dollar-denominated debt.”

The Federal Reserve System, given its position in the world, cannot just ignore all of these things currently going on, but what can it do?

Further, as I have written recently, many argue that a number of these emerging market countries got into the position they are now in because of the flood of US dollars that has been going on in the world and the very low interest rates that existed on US-denominated debt. Emerging market countries took advantage of these conditions and loaded up on the debt, for which they are not paying the ultimate cost.

Guess what? Unintended consequences... And this is just the problem that the Fed, in its current position in the world, is going to have to face. US dollars are everywhere. In addition, anything that the Fed does is going to somehow be transmitted into global financial markets and global banking systems.

But the Federal Reserve cannot just give up focusing on what the US economy needs in order to run off and do something about the Turkish lira or the Argentine peso. Then again, it cannot just ignore these crises. But what can be done.?

This is going to be more and more of a problem for Mr. Powell and his team at the Fed. The ultimate job, of course, is to let the world collapse into another global crisis. For sure, if this happens, the United States will be involved.

Mr. Powell’s job may become much more demanding than he first thought it would be.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.