Our international financial system, based on the US dollar as the dominant reserve currency, faces an unprecedented bout of flu. Following the outbreak of the financial crisis in 2007, the drawbacks of the dollar-based system have become ever more glaring, prompting a number of world leaders and central bankers to voice their concerns, with Chinese President Hu Jintao, at present on a state visit to the United States, and President Nicolas Sarkozy of France becoming its most vocal and influential critics.
The recent decision of the US Federal Reserve to inject US$600 billion into the economy, on top of the prevailing abundance of dollar liquidity, and to maintain near-zero interest rates, has created more tensions around the globe, inciting fears of a currency war.
In the aftermath of the financial crisis, the Fed has been expanding liquidity at a merciless rate. This planned money creation by the Fed on top of what was done in the aftermath of the financial crisis would lead to a total increase exceeding $2.3 trillion; meanwhile, the US can be expected to lift its debt ceiling above the $15 trillion mark. There is no letting up of liquidity expansion.
As a result of record-low US interest rates and massive dollar injections, there are pressures for dollar outflows to attractive emerging markets in pursuit of higher interest rates. Central banks around the world that want to avoid the depreciation of the dollar (that is the same thing as an appreciation of their own currencies and thus the loss of international competitiveness for their exports) are forced to use their own currency to buy up dollars. This results in a forced expansion of their own money supply, which in turn exerts inflationary pressures in their own markets.
