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A Race to the Bottom

Two and a half years ago I had written an article for this publication entitled “The USD – why is it so High?“

Yet here we are in 2015 and the situation hasn’t changed; in fact it gotten much worse.  There is a race to the bottom in terms of currencies and no one wants a higher value of their domestic currency as that means higher prices in the global market and a downturn in the sales of products those respective countries produce.  Need proof of this?  Take a look at what’s happening in China right now.  The bigger question is why is this?  We’ll attempt to explain.

Way back in 1944 with World War 2 still raging the free powers attending a conference that history calls Bretton Woods.  It is significant because at that conference it was determined that the United States would become the defacto leader of the free world and its currency, the USD as the premier currency worldwide.  It was determined that only the US could do this and that all other currencies would be measured against the USD.    Prior to that time the British Pound held that title but after WW2 it was determined that the US would be better equipped to hold sway as Great Britain had to rebuild itself after the devastation of war.

From that time to the present the USD has reigned supreme as it is the only currency worldwide guaranteed by the United States government and has been from the beginning.  Ironically this upcoming week the FOMC will meet to determine if rate hikes are warranted.  There has been much debate and speculation on this subject matter.  We at Market Tea Leaves do not believe the Fed will raise at this junction.  There are many reasons for this.  First, the Fed will be reluctant to throw a monkey into an already fragile economy.  

Second, non-existent inflation doesn’t warrant or justify a rate hike.  The Fed has stated repeatedly that inflation needs to rise by two percent to justify a hike and that hasn’t happened yet.  

Third, at this time of year the Fed will be reluctant to hike as in the US we are rapidly approaching Holiday Shopping season and the Fed wouldn’t want to do anything to force the consumer to hold back from spending.  

Fourth, the Fed will want to look at a full calendar years’ worth of data prior to hiking and they can’t do that in October.  

Lastly, in calendar year 2000 the United States Federal government operated with a 4 trillion dollar deficit and a 400 Billion Dollar interest payment on US government bonds.  Currently the US operates with an 18 Trillion dollar deficit and if interest rates rise, the US government will be paying 800 Billion in interest payments.  

Understand that US government bonds are highly valued for the same reason that the USD reigns supreme; it is backed by the US Government.  If the Fed raised rates by even .25 percent or 25 basis points they will automatically double the amount of interest the US government pays to back its bonds.  Politicians (regardless of what they say publicly) are dead set against this idea as it means that taxes will be raised and no one will run politically on that platform as they know they’ll be voted out of office.  Especially since the ever shrinking Middle Class will be saddled with that burden.  Income inequality is a very hot topic in US political circles these days.

Could this change?  Of course anything can happen in a volatile market but we’ll know for certain on Wednesday when the FOMC meets.

Nick Mastrandrea

Nick Mastrandrea

Mastrandrea is the author of Market Tea Leaves. Market Tea Leaves is a free, daily newsletter that discuses and teaches market correlation. Market Tea Leaves is published daily, pre-market in the United States. Interested in Market Correlation? Want to learn more? Signup and receive Market Tea Leaves each day prior to market open. As a subscriber, you’ll also receive our daily Market Bias video that is only available to subscribers.