Central Bank of the World

If, by chance, you’re not familiar with my work, I focus on the Federal Reserve System.

That’s the formal name for the central bank of the United States, most often referred to simply as “the Fed.” Those who are familiar with my work might even say it’s a bit of an obsession for me, and they might not be wrong.

The Fed is no small thing. It drives monetary policy, guided by a “dual mandate:”:  by following a dual mandate:  maximize jobs and wages and , stabilize prices..

Since the U.S. dollar is currently the world’s reserve currency, policy decisions made by the Fed impact not just the relative strength of the dollar but also influence everyone that does business with us – a group that includes basically every civilized country on the planet.

The Fed’s role here in the U.S. is pretty clear, but what about its international role?

Let’s back up a minute and pick our way through some history. At the Bretton Woods Conference in 1944, the International Monetary Fund (IMF) and the World Bank were created to help less developed nations build stronger economies.

The IMF’s role is to promote monetary cooperation between countries by stabilizing exchange rates and acting like the world’s traffic cop. The World Bank was created to lend money (with the promises or backing of the most powerful governments) for the purpose to aid underdeveloped nations feed their hungry and rise their standard of living.

That all sounds great…

In 1944, exchange rates were determined by how much gold a particular currency could buy in the open market (which did not mean currencies were backed by gold). Values were set by supply and demand, which was an efficient method to determine a currency’s true value.

The problem with this method was that central bankers couldn’t manipulate their currencies.

In the 1970s, gold was phased out as a standard to measure currency value. And, voila, central banks were free to manipulate their currencies without the penalty of having their currency automatically devalued by other banks.

If the pre-1970s method of valuing currency were in effect today, the Japanese yen would have likely fallen to near zero (in terms of gold purchasing power) because of the Bank of Japans’ version of quantitative easing (QE) over the last couple decades.

And what about the U.S. dollar? “Helicopter” Ben Bernanke, the former Chair of the Federal Reserve,  with the help of Henry Paulson and Tim Geithner during their respective reigns atop the U.S. Treasury Department, wouldn’t have dared implement the Fed’s version of QE in 2008.

But back to the IMF and the World Bank. Both institutions are funded by about 200 countries, but most support comes from the U.S., Germany, France, Japan, and Great Britain. The U.S. contributes nearly 20% – but if you include loan guarantees, our taxpayers are on the hook for twice that amount!

The IMF seems to be evolving into the world’s central bank, with the World Bank as its “open market” branch. These “loans” are funded by a small amount of capital contributed by the countries that fund the IMF but are mainly funded by “credits,” which are promises by participating governments that their taxpayers will cover these loans if the World Bank’s loans go bad.

And the loans do go bad!

So back to the Fed. The Federal Reserve System is very much involved in the international financial system. Total borrowing and lending in U.S. dollars by foreign financial institutions is enormous.

And when the global financial crisis hit in 2008, the Fed was ready and willing to support them via “swap” arrangements through foreign central banks. Swaps just mean swapping worthless debt for guaranteed debt or worthless currency for dollars.

Easy and painless, right?

Remember, the Fed oversees itself and is accountable to no one. After the crisis in 2008, the Fed doled out about $16 trillion to struggling corporations and banks, most of which wasn’t paid back. The Royal Bank of Scotland and Deutsche Bank split about $1 trillion, and many other foreign entities also took part in the Fed’s giveaway.

In an October 2014 speech during the annual meeting of the IMF and World Bank, Fed Vice Chair Stanley Fischer admitted the Fed’s responsibility to the global economy because of the size and openness of our capital markets and the unique position of the U.S. dollar as the world’s leading currency for financial transactions. He did caution, however, that the Fed’s responsibility is not unbounded.

Well, $16 trillion dollars in handouts without the express approval from taxpayers seems unbounded to me! Especially when considering the entire GDP of the United States is just over $14 trillion dollars!

What could be even scarier, though, is that many of our banking leaders (current and past) think the stability of the international financial system could be best supported by a global central bank. Stanley Fischer mentioned as much in his IMF speech in 2014. He wanted to be clear, though, that the Federal Reserve is not that entity.

But is that the end-game? Or is the Fed pulling all the strings right now?

You can prepare for and profit from surprises in the financial markets, and specifically in the Treasury bond market, with Treasury Profits Accelerator.

Good investing,

Lance Gaitan
Editor, Treasury Profits Accelerator 

 

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Categories: Central Banks

About Author

Lance Gaitan graduated from Franklin University in Columbus, OH with a degree in Finance. After graduating and working as an auditor for an insurance administrator as a number of years, he attained his securities license. He then went to work as a broker for a small firm and during the mid-1990’s Lance managed the futures trading desk for Piper Jaffray, a large regional brokerage firm based in Minneapolis. After migrating to Florida in early 2000, Lance founded a futures trading firm, GSV Futures, specializing in retail commodity trading strategies. Lance sold that business in 2006 and joined Harry Dent, Jr. and Rodney Johnson at Dent Research shortly thereafter.