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Fed Interest Rate Cuts Could Hurt World Currencies Down the Road

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Fed Interest Rate Cuts Could Hurt World Currencies Down the Road

By John McDonald

On Wednesday, July 31, 2019, the Federal Reserve cut interest rates for the first time in a decade in an effort to sustain the country’s longest-running economic expansion ever.

Citing “downside risks from weak global growth and trade tensions,” Fed chairman Jerome Powell said he hopes the quarter-point cut will ultimately keep the national economy going strong.

Unfortunately, the immediate effects mainly consisted of the S&P 500 falling the most it had fallen in about a month (1.1 percent) and a fair amount of presidential criticism for the already beleaguered chairman.

The Cut Could Hurt Global Currency Values and Systems

The bigger issue, however, is that the rate cut could create a crisis of confidence in many fiat currencies, including the dollar. As the Fed and other global central banks, like the European Central Bank, all move toward preventative rate cuts instead of responsive ones, investors the world over may opt to move out of currency-based assets and into precious metals, like gold.

“Ultimately, faith in the fiat-currency system relies on the perception that central banks are acting responsibly,” wrote Wall Street Journal op-ed contributors Danny Yong and Nikhil Srinivasan.

Mr. Yong is the founder and chief investment officer of Dymon Asia, and Mr. Srinivasan serves as chief investment officer of PartnerRe. They added that a loss of confidence in the U.S. dollar, in particular, “as a store of wealth,” could create a “significant capital flight, even a collapse in the currency.”

A Long Way Down the Road

Although the Federal Reserve’s policies for managing interest rates have been tending toward stimulus and preventative interest-rate manipulation for a while now, a collapse in confidence in the U.S. dollar will certainly not happen overnight.

Even with nearly a decade of holding interest rates artificially low and, now, dropping them while employment is low and equity markets are high, Americans and the rest of the world are likely to remain confident in the dollar for now.

However, over time, if this type of preemptive, vaguely-sourced policy continues, investors and other countries’ banks and governments are certainly going to get nervous.

Yong and Srinivasan speculate the situation will worsen now that the Fed has demonstrated its sensitivity to public criticism from the president, pundits, and other members of the government.

“By folding to these external pressures and cutting interest rates while U.S. equity markets are at all-time highs and unemployment is at multi decade lows, the Fed is putting its credibility at stake,” they wrote.

A natural protection against this emerging future weakness in the dollar will be, for many investors, to begin buying gold. As a safe-haven asset, gold tends to rise in value when the dollar falls or there is any type of global uncertainty. “The lack of conviction by the most important central bank in the world,” as Yong and Srinivasan describe the Fed, is certainly likely to only make that uncertainty greater over time.

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