Is the US Dollar in a strong position because of the Euro riots? Perhaps not. There are still two crucial factors that are responsible for the strength of the USD.
1.1 Source of Demand for Liquidity – The US Government Supply – Refund and Settlement System – The largest demand for liquidity is from Commercial Bankers. As is so often the case, those at the top of the supply chain, demand more liquidity than those below them in the chain. Commercial banks see the USD as a safe haven, and consequently their demand for liquidity will be affected by its strengthening position vis-a-vis the Euro and US dollar.
According to published statements by executives of credit markets, the banks do not wish to take any further financial risks on the back of the Great Recession. When the EUR/USD rises against the USD, the bank balance sheets will increase as the forex trader loan demand increases.
It is the supply of liquidity that acts as the source of demand for liquidity. It is the large number of people searching for a source of liquidity that increases the liquidity requirement. The trend of borrowing more money with interest should improve as it is currently not profitable for the average person.
Banks are not very keen to add new loans and need to keep new customers happy with existing customers. This is the main reason why the number of loans for the first quarter (January-March) was so low. In addition, bank profits were lower than projected, so there is certainly a need for the banks to prove their popularity with customers.
The US Federal Reserve has been very strict in controlling the printing of money and hence the price of dollars is under some restraint, but not really on the scale of 1999, when we saw a substantial growth in the supply of money. For example, in the year 2020, there is a 5% chance that the Fed will raise interest rates, but only a 5% chance of reducing them.
Whilst these rates are moderate, the economic environment has weakened in the last few months and the ability of the US economy to absorb a large number of new loans is questionable. So it will be hard for the bank to provide a significant amount of loans. So banks are tightening their lending criteria.
As banks are taking this extra cost into account, they will focus on their liquid assets, namely, high quality government bonds. The risk to the banks in this way is the fact that high quality government securities may become very scarce in the future and might not be able to deliver the returns on equity, which are currently offered.
Another factor that affects the demand for liquidity is the size of the market, as banks try to meet the liquidity requirements. The size of the market increases the costs of loans in two ways.
Firstly, the demand for liquidity increases when banks demand a larger loan and take a risk to gain money from the new borrower. This requires a higher capital outlay to pay off, which means that the loan increases the liquidity of the bank’s assets. Secondly, the additional loan results in the growth of the equity of the banks.
Banks should look at government securities as the source of liquidity. They are readily available and, as previously mentioned, are regarded as safe by the vast majority of the population.
As banks concentrate on the size of the market, they will be in a better position to provide a large number of loans and are in a better position to offer a healthy amount of liquidity. Government securities provide the liquidity needed.