The Fed’s Gamble on Dollar Credibility
Yopie Hidayat (Contributor)
IN the middle of the Covid-19 pandemic, a big gamble is going on. Like a player on a baccarat table who is completely assured of his victory, The Federal Reserve is going all in to save the economy and the financial market.The Fed is flooding the market, printing dollars to buy all kinds of assets, virtually without limit. Stock prices soared and formed V curve: a sharp rise after temporary drop.
The S&P 500 index, which fell from 3,400 at the end of February to the lowest point of 2,209 on March 23, already saw a 30 percent jump to 2,912 on May 11, and is still trending upward. This time, The Fed’s injection is truly incredible. In less than two months, The Fed has showered markets and the economy with trillions of dollars. The Fed’s assets ballooned from US$4.3 trillion before the pandemic to an all time highest record of US$6.62 trillion at the end of April.
And this will continue. Many analysts predict that The Fed will keep pouring money into the market until it balance sheet swells to US$9 trillion. What makes The Fed’s recent aggressive moves different from the ones made in the 2008-2009 crisis is not only the extraordinary amount, but also the types of assets that it is buying. If in 2008 The Fed only bought US government bonds, this time corporate bonds with non-investment grade are also in their sights.
In short, The Fed is doing a mass bailout, funding the United States economy to prevent a collapse. To avoid a continued surge of unemployment—which has reached 33 million workers in the latest data—The Fed is injecting money directly into corporations, an action that has been thought of as taboo. It is as if The Fed is playing God, deciding which firms can live and which will be left bankrupt.
The effects of The Fed’s policy will cast ripples throughout the world. Such a large injection of money will leak to other markets, including those of emerging economies. At least there is an optimism that the economy and the market won’t collapse because The Fed is going all in. In Jakarta, the Jakarta Composite Index has recovered from under 4,000 at the end of March to over 4,500 now. The same goes for the rupiah which, after weakening down to more than Rp16,500 per US dollar at one point, is now relatively stable at around Rp15,000 per dollar.
But questions are beginning to emerge regarding the US dollar credibility. Considering that the Fed has been so aggressive in increasing its assets by printing dollars, does the dollar still deserve to be trusted as a currency for international transaction and reserve currency? Indeed, the world has no alternative to the US dollar. There is no economy or currency in the world that is trusted as strongly as the US economy and its dollar. However, doubts are starting to appear.
One of the indicators that show how the market is starting to be wary of The Fed’s aggressive moves is the price of gold. The price movements of this precious metal is curious, as it had fell when the Covid-19 pandemic started to take hold around the world, going down from US$1,680 per troy ounce on March 9 to US$1,450 one week after that. At that time, investors preferred to hold US dollars as a safe haven in uncertain times. But after The Fed started printing dollars with such aggressiveness, gold prices rose sharply. As of Monday, May 11, the price of gold has reached US$1,700 per troy ounce.
Is this an early taste of post-pandemic life? Perhaps it is not only social life that will change drastically. The financial markets and the global economic landscape might be forced to mutate with extreme velocity. If The Fed’s balance sheet really does explode to US$9 trillion by the end of the year, can the global market still accept and trust the US dollar as the main currency for foreign reserves, regardless of the fact that they have to due to the lack of alternatives?
If that trust is broken, it will be truly ironic. An economy as powerful as the US and its dollar is dethroned by the invisible SARS-CoV2.