Weekly Geopolitical Report – Reflections on Domestic Policy and American Hegemony: Part I (April 15, 2019)

by Bill O’Grady

(Due to the Easter holiday, our next report will be published April 29.)

The dollar is the world’s reserve currency.  As such, there is a constant demand for dollars from foreign countries to provide liquidity for global transactions.  Because of the reserve currency status, U.S. monetary and fiscal policy affects the world economy in ways that other nations’ policies do not.  The Federal Reserve is the U.S. central bank; in its mandate, it only concerns itself with the U.S. economy unless overseas events directly affect America.  In general, the Federal Reserve would not be allowed to cut U.S. interest rates to boost the Canadian economy.  Fiscal policymakers almost never worry about the impact of spending or taxes on foreign economies.  However, U.S. monetary and fiscal policy can affect foreign economies through access to the reserve currency and trade.

Previous reports have discussed the reserve currency role.  Recent policy decisions and potential Federal Reserve governor appointments could have a dramatic impact on monetary and fiscal policy.  At the same time, because of America’s superpower status and its role in providing the reserve currency, these policy actions will also impact foreign economies.  The key issue is the degree to which the U.S. can use hegemony to force domestic economic adjustments on foreigners.

In Part I of this report we will review the basis of the reserve currency role and the impact of the savings identity.  In Part II, we will examine the power of hegemony by historical comparison, using the Nixon and Reagan administrations as analogs.  In Part III, we will examine how the Trump administration is using American power to force foreign economies to absorb at least part of the economic adjustment.  Our normal analysis of potential market ramifications will conclude the third installment.

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