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FUNDAMENTAL ANALYSIS


FX


reserves in isolation, something clearly changed in 2014, since which time reserves have dropped by well over US$1 trillion. With this reduction much greater than during the 2008 crisis, should we not have expected both the global economy and financial markets to be suffering again? Furthermore, with the US current account deficit pretty static in the last couple of years, and the US Dollar strengthening by some 20%+ over


the global economy and financial markets


the same period, should be


Chart 2 - Te Global Economy with US current account, US Dollar and Global FX Reserves


since 2012. But what of Global FX Reserves? The usual mechanism of


reserve accumulation is that


a country’s monetary authority intervenes to buy US Dollars and prints local currency to pay for this intervention (this is a bit simplistic, but serves as an illustration). By printing local currency, the non US monetary authorities increase their domestic money supply, which is of course stimulus.


In terms of the Dollar side of the equation, the non US monetary authorities buy US$ denominated assets with the Dollars they have bought, quite often US Treasuries. With global FX reserves having increased by nearly US$10 trillion between 20013 and 2014, that’s an awful lot of non US monetary


stimulus going on. Furthermore, the continuous purchase of US Treasuries will surely have suppressed US interest


rates to some degree.


As an aside, it is mostly this $10 trillion increase in FX reserves that is alluded to when the likes of Bernanke and Yellen talk about a global savings glut. We would contend that it is not in fact a savings glut, but the result of years of massive intervention on the part of several countries (China the biggest culprit) leading to massive stimulus in non US economies and a suppression of US rates. The so- called savings glut certainly helped the global economy both before the crisis and during the recovery cycle.


It also helped asset prices. If we were to look at global FX


surely both in turmoil?


Enter two new actors. As noted above, as the European crisis erupted into 2011/12, the ECB tepidly increased its balance sheet (via liquidity as opposed to outright QE initially) followed in 2013 by the Bank of Japan. Now, apologies for the next chart which is getting a bit messy, but we think it is important to try and understand. Chart 3 incorporates most of chart 2’s components, except we have removed Global GDP and added back in the Fed’s balance sheet and also an index showing the combined balance sheet of the ECB and Bank of Japan measured in US Dollars. We have also put in a dashed vertical line at the point in 2014 when things changed.


As we said above, with FX reserves dropping, a static US current account deficit and a rampant Dollar, we would have thought that the global


FX TRADER MAGAZINE January - March 2017 35


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