The World Gangs Up on the Dollar
One of our clients’ recurring concerns is the long-term viability of the US dollar as the world’s “reserve currency.” I have a simple answer for them:
The dollar is doomed.
I don’t read tea leaves or own a crystal ball. But, I’m confident in my prediction that every fiat currency in existence eventually becomes worthless. The dollar will not be an exception to this rule.
To be sure, I have no idea when this will occur. It could happen later this year or a few years from now. It’s even possible the dollar’s death could be postponed beyond the lifetimes of anyone alive today.
But make no mistake: the dollar will die. Indeed, it’s lost almost 99% of its value relative to gold since the creation of the Federal Reserve in 1913.
What’s more, the actions that Congress, the Treasury, and the Federal Reserve have taken to combat the COVID depression will hasten the greenback’s death. In just the last six months:
The Fed cut interest rates to zero and more recently announced it would keep them at zero at least until 2023. It has also nearly doubled the assets on its balance sheet, for a total now exceeding $7 trillion.
Inflation has rekindled with the official inflation rate now running at a 7.2% annual rate. (The real inflation rate is several percent above the official rate, as I explained here.)
Thanks to the CARES Act bailouts and reduced tax collections, the federal deficit for the first 11 months of fiscal year 2020 came in at a whopping $3 trillion – more than two times as much as any previous year. Total federal debt now exceeds $26.7 trillion – almost one-third higher than it was when President Trump took office in 2017.
Should further stimulus be necessary, the Fed is reportedly considering a bailout strategy to transfer digital moneydirectly into the neediest Americans’ smartphone financial apps. Since these funds would likely be spent immediately on goods and services, the bailout would be highly inflationary, further ramping up prices.
None of these developments are good for the greenback. The markets have made it clear that investors are headed for the exits. Indeed, the price of gold – rightfully referred to as the “anti-dollar” – has risen by nearly 15% since the COVID crisis began. Warren Buffett, who has repeatedly bashed gold, recently purchased a big stake in mining giant Barrick Gold while selling shares of money center banks. Moreover, the Dollar Index, a measure of the dollar’s value against a basket of currencies of America’s largest trading partners, has fallen 10% in the same period.
But there’s another trend at work as well. For over 75 years, the dollar has essentially been getting a free ride, courtesy of the fact that it’s the world’s most popular currency. Because so many global transactions are settled in dollars, businesses in every country need to exchange local currency into dollars to pay debts and transact business. The domination of the dollar is so complete that more than 60% of global currency reserves held by central banks are dollar denominated. For this reason, the dollar is often referred to as the world’s “reserve currency.”
Having the world’s reserve currency has numerous benefits. The biggest one, of course, is that it forces other countries to accumulate dollars even while their value is falling. With reserve currency status secure, American politicians have found ways to weaponize the dollar against Uncle Sam’s enemies. For instance, one of the ways the US enforces sanctions against its long list of adversaries by making it difficult for them to use or accumulate dollars.
Understandably, the countries threatened by this policy don’t like it. And they’re taking concrete steps to isolate themselves from the dollar. These efforts have only accelerated in the COVID era.
In 2019, Russia and China agreed to increase trade using their own national currencies. Since then, the dollar’s share of payments of Russian exports to China has plummeted from nearly 90% to 33%. In addition, the EU has developed a global payments system designed to allow EU companies to do business with Iranian companies without exposing themselves to US sanctions. As well, over 40 central banks, including the Bank of China, are considering the introduction of blockchain-based digital currencies that would avoid dollar clearing delays and US sanctions. China is also setting up its own financial clearing system to reduce its reliance on the dollar.
Investment bank Goldman Sachs claims these developments, among others, create “real concerns around the longevity of the US dollar as a reserve currency.”
But when will the greenback be toppled from its increasingly precarious perch? I don’t believe it will be anytime soon. In its 2020 annual report, the Bank of International Settlements, the world’s “central bank for central banks,” revealed that the volume of dollar denominated debt issued internationally is at a ten-year high. And dollar denominated debt issued in emerging market countries reached a new record. Even China is increasing its dollar-denominated debt; it’s risen 35% since 2015 while its foreign currency reserves fell 10%.
Meanwhile, other countries are busy depreciating their own currencies. Both the European Central Bank and the Bank of Japan have been nearly as aggressive as the Fed in policies designed to spur economic growth.
In reality, no other currency is a serious candidate for reserve currency status. The euro is the most obvious contender, with central banks holding about 20% of their reserves in this currency. However, if any country pulls out of the Eurozone and reintroduces a weaker domestic currency, its value could fall sharply. This “redenomination risk” makes the euro a poor candidate for a reserve currency. Meanwhile, the Chinese yuan will never become a reserve currency so long as the government maintains strict exchange controls. And in any event, only about 4% of central bank reserves are held in yuan.
That leaves gold. In theory, the world could return to a gold standard, but doing so would likely lead to an even more serious economic crisis than we are now experiencing. If its price is set relatively low, it is likely to lead to a deflationary depression as individuals, businesses, and governments convert their savings from fiat currencies to the precious metal. The resultant collapse in demand for goods and services would lead to a deflationary spiral and a depression far worse than the 1930s.
But if the price of gold is set high enough to reflect the fact that the dollar has lost 99% of its value in the last century, it would cause hyperinflation as every asset not directly backed by gold is repriced in terms of its new value. Can you imagine waking up one morning to discover that all goods and services are now 100 times more expensive than they were when you went to bed?
Yes, the dollar is doomed – eventually. But until a viable contender emerges that serves the global economy better than the dollar, the greenback will reign supreme.
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