US Dollar To Rain On Gold’s Parade

From the summer of 2014, to-date the ECB has been easing while the U.S. monetary base has been level to falling and the U.S. dollar has been generally rising except in 2017 when the U.S. monetary base rebounded modestly and the U.S. dollar eased.

Fed Reduces Balance Sheet

Throughout the past year, the U.S. monetary base and the Fed Balance sheet have been contracting while the ECB has continued to ease causing the U.S. dollar to strengthen. While the ECB has talked about ending its QE, the U.S. monetary base and the Fed’s balance sheet are set to continue their declines. This QT could well push the U.S. dollar higher until the ECB itself starts to contract its assets, which may take some time given the weakening of the Euro area economies and the possible impact of Brexit.

A continuation of European QE combined with U.S. QT should result not only in a higher dollar but also imported disinflation. While this would be good for U.S. domestic inflation, it appears that both the U.S. government and the U.S. multinationals are not in favor of a much stronger dollar. Thus the Fed could well hold off any further increase in the Funds rate until the ECB begins to tighten, an unlikely event for at least a couple of years. Furthermore, one must also consider the impact of a falling Chinese currency.

Fed has New Levers to Pull post-Lehman.

To offset the impact of the 2008 financial crisis that stemmed from the collapse of the sub-prime mortgage bubble of the preceding three years the Fed expanded rapidly the U.S. monetary base to re-liquefy the banking system. This continued until 2014 with most of the increase ending up as excess bank reserves held at the Fed.

(Click on image to enlarge)


For the first time in late 2008, the Fed paid interest on the excess reserves (IOER) which helped the banks rebuild their balance sheets and keep their executives in the bonuses and lifestyles to which they believed they were entitled. This together with fear, increases in reserve requirements and new regulations that stifled borrowing, all coalesced to delay the impact of the increase monetary base moving through to the real economy. This resulted in a very slow recovery from the great recession.

At its peak in August 2014, the U.S. monetary base stood at $4.1 trillion of which the excess reserves amounted to $2.7 trillion. The impact of 6 years of QE was essentially sterilized by the Fed. In August 2008 just prior to Lehman the U.S. monetary base stood at $0.84 trillion and the excess reserves amounted to a minute $2.0 billion. By August 2016 the monetary base had increased 5 fold to $4.1 trillion while the excess reserves increased to $2.7 trillion. The amount of the monetary base at work in the economy rose by only $0.5 trillion from $0.84 trillion to 1.4 trillion.

Actual Working Monetary Base. AWMB

The amount of the monetary base actually at work in the real economy is calculated by subtracting the excess reserves from the total monetary base. This is shown in the next chart as the red line and denoted as the Actual Working Monetary Base (AWMB). The much more moderate growth of the AWMB along with changing regulations and fear would seem to explain the slow pace of economic growth post-Lehman.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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