Three Things I Think I Think – Losing Reserve Currency Status

Here are some things I think I am thinking about.

1. Is the Fed “Playing with Fire”? 

Stan Druckenmiller had an op-ed in the WSJ about how Fed policy has been too loose for too long. I think there are some reasonable perspectives here. I’ve been pretty vocal about the risk of inflation overshooting the Fed’s target this year. I also think there’s an increasingly convincing argument that the Fed’s policies have contributed to a lot of financial market craziness in the last year. It would not surprise me at all to see the Fed backpedaling later this year or in 2022 as they unwind the balance sheet a bit and raise interest rates to try to contain inflation and the housing market.

At the same time, I think this was a risk worth taking. For instance, let’s say the Pandemic had turned out to be much worse than expected. In that case, the extra stimulus wouldn’t have been nearly enough. Personally, I think we’re in the clear now and the Fed should be more forward-looking, but it was worth dumping gasoline on this fire back in 2020 because the downside risk (a huge deflationary collapse) was worth the upside risk (3-4% inflation).

2. Dollar Reserve Status at Risk? Druck went on CNBC this morning explaining this argument in more detail. He said that the government’s policies endanger the Dollar’s Reserve status. This is a pretty familiar refrain on this website and one that I just think goes too far. I’ve discussed this concept a bunch in the past. Basically, reserve currency status isn’t like a set of car keys. You don’t just up and lose it. Historically, countries lose reserve currency status over hundreds of years. Similarly, reserve currency status is earned over hundreds of years by producing so much output that the rest of the world ends up necessarily needing your financial assets because they’re the assets that are supported by most of the world’s output.

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