Even the loonie is rising against the U.S. dollar as the Fed faces currency threat: Don Pittis

Goldman Sachs warns that the U.S. dollar's place as the world reserve currency faces threat as the American economy is weakened. Can Federal Reserve chair Jerome Powell maintain his promise not to even think about thinking about hiking rates, Don PIttis asks.

Economy battered by COVID-19 and a promise of endless low rates puts Federal Reserve in tricky spot

U.S. Federal Reserve chair Jerome Powell, left, and U.S. Treasury Secretary Steven Mnuchin bump elbows after a hearing of the House of Representatives financial services committee in Washington, D.C., on June 30, 2020. (Tasos Katopodis/Reuters)

No one will be surprised if Federal Reserve chair Jerome Powell uses part of his news conference on Wednesday to scoff at the idea of the U.S. dollar losing its place as the world reserve currency.

But even as he scoffs, the comments this week by strategists at global finance giant Goldman Sachs that "real concerns around the longevity of the U.S. dollar as a reserve currency have started to emerge," will certainly be in the minds of everyone listening to the Fed's latest plans.

Predictions of the mighty U.S. dollar's fall from its place as the ultimate measure of value are nothing new.

"Gold bugs" — the slightly disrespectful term for people convinced the yellow metal is the only truly safe investment — roll out an attack on the U.S. dollar's safety every few years.

Deposing king dollar

The euro has been an aspiring candidate, but has had many troubles of its own. Countries that don't get along with the U.S., including Iran, have complained about the absurdity of having to sell their oil to third parties priced in U.S. dollars.

After the global financial meltdown of 2008, China's then central banker, Zhou Xiaochuan, criticized the use of a single country's currency for a world standard, calling it a historical anomaly.

"The crisis again calls for creative reform of the existing international monetary system toward an international reserve currency with a stable value, rule-based issuance and manageable supply," wrote Zhou.

But the comments from New York bankers Goldman Sachs just as gold is hitting new highs and the greenback is hitting new lows are quite different from bellyaching from those who would like to take the dollar's place.

Most people in finance will tell you, as financial specialist Kamal Smimou once told me, that dislodging the U.S. dollar from the key place it has held for 75 years since the Bretton Woods conference would be disruptive and costly.

But the Goldman comments act as a warning of what might happen if the U.S. currency eventually becomes debased through too much government spending and too much borrowing at interest rates close to zero.

Fear of debasement

"The resulting expanded balance sheets and vast money creation spurs debasement fears," said the strategists' report.

That puts Goldman in the inflationist camp, adding their voices to the idea that central banks will be afraid to raise interest rates even in the longer term.

That's certainly the impression the central bank chair seemed to offer at his last news conference when, in his most quotable statement, he promised that higher rates were not on the cards.

"We're not thinking about raising rates," Powell said in June. "We're not even thinking about thinking about raising rates."

Perhaps now the bank will at least have to start thinking about thinking about it, or at least explain what its strategy will be if the currency continues to fall or if inflation shows signs of perking up.

The Canadian dollar is up two cents against the U.S. currency in the last month. (Heinz-Peter Bader/Reuters)

Even the Canadian loonie has been on a tear against the U.S. dollar, perhaps a sign that even with the WE controversy in Ottawa, Canada is seen as a relatively stable country and a healthier economy than some.

The Canadian dollar is up two cents against the U.S. currency in the last month. But as usual, that is deceptive. With most of our trade happening with the U.S., the loonie tends to rise and fall with the U.S dollar. The loonie continues to trade lower against the euro.

The Goldman Sachs report is making lots of headlines and offers a little thrill of dread to those who are looking for an even more dire outcome from the current pandemic. But gold quite regularly rises in value during times of financial uncertainty and it tends to fall shortly after.

Speculation not investment

When the U.S. economy starts chugging along again, gold will once again be expensive to hold and will still provide no investment return. The rule from the past is the only people who make money by buying gold are those who sell fairly quickly, before it plunges again.

The fact is, Goldman's fearmongering may be playing into the hands of Powell and other central bankers. Research has shown that one of the biggest predictors of inflation is what people think inflation will be.

Perhaps Powell and Bank of Canada governor Tiff Macklem would be pleased for people to think inflation is on the way back, thus offering a little more insurance that its evil twin, deflation, will be driven away for good.

But with so many of our longstanding rules about what causes inflation seeming to be in abeyance, the potentially perilous consequences of the Goldman Sachs warning mean that it will be hard for central bankers to completely ignore.

Follow Don on Twitter @Don Pittis