What the Fed does on interest rates matters not just to Americans, but the entire global economy — and that’s because the dollar continues to tighten its grip as the world’s reserve currency.Foreign investors holding trillions in securities and dollar assets have an incentive to the keep the currency afloat — even when the value of the dollar declines.
It’s what Cornell economics professor Eswar Prasad calls the “Dollar Trap.”
“The financial crisis had its origins in the U.S., the federal reserve has been pumping huge amounts of dollars into the global financial system, which ought to cheapen its value.” Prasad says. “[But] In times of turmoil, the world wants safety, and the U.S. is still seen as the safest place to invest.”
So what happens if the world loses faith in the dollar?
Prasad examined several tipping-point scenarios. He found this could result in turmoil for the U.S. financial market, and in turn, spread to the rest of the world.
“The dollar’s value is stronger than it ought to be. That means fewer jobs, less exports, so it’s not all together a good thing for the U.S.,” he says.
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