For years, the United States has been “borrowing” money from countries around the world. The size of the US debt has exceeded $25 trillion and this amount of debt is still growing. Many countries around the world are in fact “debtors” of the United States. The total debt of the United States exceeds its annual gross domestic product. The Federal Reserve’s money printing frenzy during this epidemic has had a significant impact on both the US and other countries around the world. The “printing of money” here includes both base money (the money actually issued by the Fed) and broad money (the price level of society as a whole).

1. US domestic analysis

I suppose the reason why the United States dares to print money like crazy is because the U.S. dollar is currently the currency in global circulation and is directly linked to gold.

Generally when a country’s currency is over-issued, there will be more and more currency in circulation on the market, and the country’s currency will depreciate, causing prices in the country to rise, thus forming inflation; conversely, when there is less and less currency in circulation on the market, there will be deflation, manifesting itself as a fall in prices in the country. Moreover, in countries with high inflation rates, the foreign exchange rate rises and the exchange rate of the national currency falls (the foreign currency appreciates and the local currency depreciates). At the same time, the US dollar generally acts as a means of international valuation, a means of payment and a second reserve, so a fall in its exchange rate will lead to economic losses for the economies holding the currency. Instability in the exchange rate of the US dollar can have a huge impact on the international reserve system and the international financial system.

But the Federal Reserve has not only done the opposite during the epidemic, but prices in the US also have fallen rather than risen, partly due to the impact of plummeting gasoline and energy prices, and partly due to the “embargo” caused by the epidemic, which has led to a massive reduction in domestic and foreign consumption, resulting in prices falling rather than rising.

The US is not experiencing huge inflation precisely because of the special nature of the US dollar, which generally floats separately, depending on the supply and demand in the foreign exchange market. Since World War II, the influence of the Bretton Woods system, which provided for the dollar to become the international reserve currency, the “dollar-gold” standard system was implemented and a “dual peg system” was set up, and later, even though the Bretton Woods system collapsed, soon the “dollar-oil” peg was re-established, and because all countries in the world that were developing their industries needed to import oil, and the dollar was inevitably used in country-to-country transactions, thus securing the global circulation of the dollar. In addition, the dollar has always been recognized by investors as a safe-haven asset similar to gold, and many countries and investors have purchased large amounts of US debt in order to hedge their bets. This time, the United States was printing money like crazy, a large amount of dollars flowing not only to the United States domestic, but also to countries around the world, so the United States was alleviating its own difficulties by transferring its own crisis to other countries. Investors have lost a lot of money because they hold a lot of US debt and have been affected by the exchange rate.

For the time being, the frenzied money printing will damage the credit of the US dollar, but there is no way for the countries of the world to resist this event on a large scale, because even though the RMB has been reforming and trying to improve its status, the RMB is not yet a global currency like dollar and thus all that countries can do now is to minimise the risk, and there is still no way to shake the position of the US dollar.

1. Analysis of different countries

A currency swap agreement is an agreement between the monetary authority of one country (region) and the monetary authority of another country (region) whereby it is agreed that under certain conditions, either party may exchange a certain amount of the local currency for the equivalent of the other party’s currency, often used for bilateral trade and investment settlements or to provide short-term liquidity support for financial markets, with both parties exchanging back the local currency upon maturity and the user of the funds paying the corresponding interest at the same time. The U.S. money printing frenzy has caused countries with reserves of U.S. dollars to suffer a devaluation of the reserve currency – a reduction in the real value of the reserves of the reserve country – and a reduction in the U.S. debt burden.

( I ) China

China has long held more than $1 trillion in US Treasuries, making it the second largest creditor of the US. In theory, whether it is a floating exchange rate or a fixed exchange rate system, inflation occurring abroad can easily be transmitted to the country, and since the RMB is also pegged to changes in the US dollar, a drastic printing of money by the US would have an adverse effect on the Chinese economy. However, as China’s foreign exchange system is under control, the overall trend will be relatively well controlled. China’s current foreign exchange controls are: a single, managed floating exchange rate system based on market supply and demand, regulated by reference to a basket of currencies.

Reasons for China’s large dollar reserves.

a). China relies heavily on oil imports, and because of the “dollar-oil” peg, it needs to hold large reserves of US dollars, so foreign exchange reserves are a prerequisite for China’s energy security.

b). China has a large number of transactions with the United States, which require reserves of US dollars for settlement. Some of China’s large-scale transactions with other countries also require the US dollar as a third currency for settlement.

c). As the US dollar is the world’s circulating currency, it is relatively safe and liquid, and storing large amounts of US dollars minimises risk.

Reasons why China has a large amount of US dollar treasury bonds.

a). High security

b). High interest rates year-on-year (US 10-year treasury bonds pay 3%, much higher than other countries)

c). High liquidity

In the US practice of transferring the crisis, China’s central bank has also adopted two strategies to balance the foreign exchange market: local and foreign currency swaps, and central bank notes. For example, on 15 April 2020, the Chinese central bank carried out a one-year 100 billion yuan MLF operation and lowered its interest rate to 2.95% from the previous 3.15%, which was the second MLF rate cut that year. The Central Bank’s interest rate cut has also stabilised the RMB exchange rate and the domestic financial market.

( II ) Other countries

Although the Federal Reserve started unlimited QE, many countries still invested additional money in US Treasuries during the epidemic, which was because of the high yields on US Treasuries. In addition, the US’s plan to deflate requires a corresponding response from the rest of the world’s economies, so the US has also nominally operates dollar aid programmes for a number of countries, and during the epidemic, as far as I can see, the US reached temporary currency swap agreements with 14 Asian countries. The local currency swaps are a way to counteract the easing between countries to ensure market stability. But for emerging economies whose economies are not strong enough, they have to suffer the ill effects of massive US deflation. So maybe other countries should continue to increase the influence of currencies other than the dollar, reduce the situation of the dollar dominance, “de-dollarisation”.

Sum up:

There have been many similar events and moves in the US throughout history, the root of which is closely related to international capital flows, both in developed and developing countries, either for profit motive, risk aversion, or insufficient funds to make up for the deficit. Capital controls cannot be maintained in the long term either. And in order to avoid the outbreak of an international debt crisis, face the challenge caused by the epidemic and stability is the main concern.

By Sherry Song Dhu