QE Does NOT Weaken The Dollar. Here Is Why. 1
QE prints more dollars, this increases the supply of USD, and since higher supply = lower prices, USD will weaken. SELL SELL SELL!
Okay, simple enough linear logic that is easy to follow, but is this really what’s going on?
Nope.
As confusing as it sounds, USDs are being printed, but they are not really USDs.
This is because QE increases the amount of Reserves in the American banking system, but banks do not lend Reserves.
As such Reserves do not leave the banking system, at least not in a way that allows for the level of USD depreciation that the “Sell USD because QE” crowd has in mind.
Since Reserves are stuck on bank balance sheets, they do not count as USDs that the broader American economy, much less the international economy, has access to.
In other words, QE has not changed the supply of USDs that really matters – those in circulation.
Furthermore, context is important. In the case of QE, the context is, economic conditions are pretty bad (if not why bother with QE); and when conditions are pretty bad, the USD tends to do well.
This is a chart showing the USD’s exchange value against a basket of global currencies:
As you can see, the USD has been rallying for a decade.
From the very basic, but still extremely important, standpoint of supply and demand, a rising price means that demand is relatively higher than supply.
That is, dollars are scarce.
The reason for this is, for better or worse, the USD is the world’s reserve currency. This means that international trade tends to be conducted in dollars, as this gives sellers multiple advantages, not least of which is very easy convertibility into other assets/currencies.
Hence, in times of stress where markets are freaking out, non-American companies and governments, especially in the Emerging Markets, have to rush to get their hands on as many USDs as they can.
They do so to ensure that they have enough USD liquidity to cover not only their current USD liabilities, but also their USD liabilities in the near future. The more USD-centric a company’s line of business, and the more USD-centric a country’s economy, the more they will scramble and struggle in such times.
This is why, while there will be large and volatile spikes in both directions of the USD’s value during times of crisis, the overall trend will be towards a stronger dollar.
Maybe SELL SELL SELL! is not such a good idea after all.
Do You Want To Make Money Trading?
Learn how to, and more, in our Trading Courses.
