‘World politics matter’ a statement to which you naturally respond “No (kidding), Sherlock”. This monthly communication is to state that world financial systems also matter, and to give you semblance of how lucky the United States is in that regard. However, there are a few things we need to keep on the back of our minds and hopefully on the forefront of Washington policy.
Low interest rates exist in many places around the world. They exist here as a facet of USA federal monetary policy that has elected to keep interest rates low, and which are enforced mostly by the Federal Reserve setting low levels on key throttles that it does control. Principal among these tools are the Federal Funds Rate (which banks use to lend money back and forth, and to the Federal Reserve itself) and the Federal Reserve Ratio (and tad esoteric metric that says how much ‘safe money’ banks must hold for every depositor dollar they have on their balance sheet).
Currently, you may know we have a Fed Rate of near zero, though they (Chairman Janet Yellen, and friends) are talking about increasing it to something infinitesimally greater than zero. They desire to keep the rate low in order to stimulate the economy. Whether it’s working is another topic that we’ll review another day. However, the point I’m raising here is the interest rate is currently low, and STILL other countries in the world buy our country’s bonds. They buy these bonds because even though interest rates are low, the US dollar is considered the world’s primary ‘reserve currency’. But will that reserve allure last? There is a real cost to these other countries letting the dollar be the lead. When we American’s catch a cold, it is the rest of the world that coughs. Consider these remarkable facts[i];
- America accounts for 23% of global GDP and 12% of merchandise trade, yet about 60% (!) of the world’s output and people live within a de facto dollar zone, in which currencies are pegged to the dollar or move in some sympathy with it.
- America is the biggest export market for 32 countries, down from 44 in 1994. China has risen from 2 to 43, respectively.
- Decisions by the Federal Reserve affect off-shore dollar debts and deposits worth about $9 Trillion.
Due to the outsized importance of this free world economy, people buy / come here for financial safety. When you generate demand, you create a favorable market for your goods. Our goods on the federal monetary level, are bonds (Bills, Notes, Bonds – when issued by the US Government, they are called ‘Treasury’s because the Department of Treasury issues them). Today these rates are extraordinarily cheap. However, if the elixir of the reserve currency is lost, we will also experience pain in the form of higher interest rates. Witness Greece at present; 10 year Government Bonds must offer a minimum of 7.755% to attract investors (forget about the additional currency risk). The current Department of Treasury rate on 10 year bonds is 2.25%. The difference is 5%, and any elementary school kid could do the impact math on $17 Trillion of government debt. A 5% increase in financing our country’s debt would cost taxpayers an additional $850,000,000,000 ($8 B) PER YEAR. This exposure makes the recent Budget deal in Washington look like chicken feed.
Thus, if you lose the appeal of a reserve currency, you lose some of the control you now command. We are a powerful, productive economy. Betting on US companies has been a very wise move for many years, and promises to continue to be. But yet never forget the fact we are in a global market. If we forget our dependence on attracting talent to the US (immigrants) or money (direct investments or financing through government bonds), there will be a huge price to pay. Washington needs to keep in mind its fiscal responsibility to its citizens.
…and we’re keeping in mind our ongoing fiduciary responsibility to you. Hopefully you have found this information useful as we strive to serve you well.
[i] “Dominant and Dangerous” (Economist, October 3, 2015)
