Recently, the U.S. Federal Reserve generated headlines when it announced a rate cut to benchmark interest rates. This was the first time since the Great Recession that the central bank made such a move. Although surface-level metrics such as low unemployment and strong-ish GDP make this tactic appear unnecessary, the Fed adopted a pro-active approach against a slowing global economy. Unfortunately for them, though, the currency wars make the cut ineffective.
Consider the benefit of an interest rate cut. For one thing, it makes borrowing costs lower. That’s good news for individuals and entities across the board. We are a nation of debt. At last count, the national debt is well over $22 trillion. Consumer liabilities for most discretionary purchases – the worst kind of debt – has absolutely skyrocketed.
But with a rate cut, borrowers get to pay back their liabilities with dollars that are worth less. Theoretically, affected entities can pay back their obligations quicker than before a rate cut.
Also, a second point: lower borrowing costs obviously encourage borrowing. Essentially, this increases the monetary supply as people take out mortgage loans or business loans. All other things being equal, this is an ideal time to buy a home or start a business.
But if you think this is a little bit too easy, it is. If rate cuts are all that’s needed to boost the economy or stave off a recession, every central bank would do it. But the underappreciated currency wars has put a monkey wrench in the Fed’s plans.
Currency Wars Prevents Immediate Prosperity
In prior generations, the Fed exercised tremendous fiscal hegemony because they could get away it. As the uncontested capitalistic superpower, everyone had to do business with the U.S. to survive.
But while we’re still the uncontested military superpower, we can no longer say that from an economic perspective. Due to globalization, even the U.S. is dependent on international powers like China. And this new paradigm is what makes the currency wars so tricky.
Yes, the Fed can essentially devalue the dollar, making their exports more attractive in foreign markets. But that doesn’t mean other countries are going to take such a move sitting down. Prior to the U.S.-China trade war, major players had a gentlemen’s agreement not to over-engineer their monetary situation.
But with the trade war, it’s game on. And in this case, we really shouldn’t spend as much time worrying about trade implications. Rather, the focus should be on the currency wars. With embargoes and sanctions, there’s no incentive to play nice with financial engineering.
That’s why the greenback really didn’t drop in value as much as some anticipated. It’s also the reason why several foreign currencies also declined in value.
If the Fed wants to devalue, don’t expect other countries to take that decision lying down.