My friend Doug Casey likes to call the US dollar an “IOU nothing.” The euro is a “Who owes you anything?” All fiat currencies are floating abstractions.
I agree—but they’re still legal tender.
Citizens are effectively required by law to accept national currency in payment for goods and services.
They have to use them to pay their taxes.
Until this changes, fiat money will be necessary in today’s world—for all but hermits living on a subsistence level.
Or, as the crypto crowd might say, there’s still a strong use case for the USD and its ilk.
This creates demand… and some level of value, even if that crumbles over time.
But the USD has an extra source of demand-driven value: the petrodollar system.
If you want to buy oil from Saudi Arabia & Friends, you need US dollars to pay them.
This is starting to change. The Chinese, Russians, and others are increasing their ways to trade oil without using USD. And the new energy paradigm itself means the petrodollar will be going the way of the dodo sooner or later.
But for now, oil remains essential and it trades mostly in USD, cementing the USD on its throne as the world’s reserve currency.
It’s not just governments and corporations that need USD to buy oil, however. The dollar’s apparent solidity over decades has created a secondary source of demand and value: high levels of confidence in the USD all around the world.
As much as the dollar is being debased, it’s still seen as “the healthiest horse in the glue factory.” This lesser of evils confidence has millions of ordinary people around the world stuffing dollars in their savings accounts, under their mattresses, etc. That creates more demand, which enables the US to print more dollars than the US economy alone could absorb without more visible price inflation. As the excess is sent abroad, there’s less inflation in the US and more in those countries—especially the ones that resort to printing local currency to pay back loans in USD.
Does this mean that the US can continue to print all the money politicians want and experience no inflation?
I’d say no. But that’s a theoretical question. It’s more important to answer a practical one:
What might prevent inflation from remaining the #1 US export forever?
I’ve been thinking about this for some time, and I see two distinct possibilities.
End of the Petrodollar
It’s very clear to me that a sudden change in the petrodollar system could change everything.
This may seem unlikely, as Saudi Arabia appears inescapably bound to the US…
But what if China offers them a better deal?
There is a culture clash between the US and Saudi Arabia that threatens the ruling elite’s way of life. The Chinese government couldn’t care less about women’s rights in Saudi Arabia and other OPEC countries. Nor do they care about other laws that Westerners object to in such places.
If China offers the kings of the hills in such countries economic and military support in exchange for selling oil in yuan, they’d have to be tempted.
Some analysts say that such a shift would lead to open warfare. I’m not so sure. We’re talking about nuclear powers here. Nobody with the power to do so has been willing to start that fight for decades.
I’m not saying that China and Russia are about to upend the petrodollar system. I’m saying they’re working in that direction. Nor could I say when a major shift in this regard might happen. But I do think the increasing split of the global economy into US- and China-dominated hemispheres increases the odds that it will happen.
The Fed Bites Off More than it Can Chew
I see another, completely different threat to the USD’s reserve currency status: runaway inflation.
This too seems unlikely to most mainstream analysts. Given persistent low CPI inflation for many years—even after all the money printing in 2008—it seems silly to talk about hyperinflation in the US. I do think that’s possible, but inflation doesn’t have to be hyperinflation to knock the USD off its throne. Regular high inflation could do the job just as well.
Let’s suppose that the massive new wave of easy money now clearly on the horizon becomes reality. Let’s say that the government hands out so much money that not only is there no deflation, but we get CPI inflation well above the Fed’s “symmetrical” target. After some time, it may seem that the Fed will have to move to rein it in… but it might not. Not until it’s too late, at any rate.
Impossible?
Not at all; we’ve seen stagflation in the US before.
If prices start rising without the economy growing, the Fed won’t act—not quickly or boldly. If stagflation persists, it will be very, very difficult for the Fed to tighten significantly.
The Fed has already communicated that employment is the higher priority of their “dual mandate” for full employment and stable prices.
This means the USD is going under the bus. They may think it’s temporary, but every step of the way, they’ll be afraid of overdoing it. And that means the Fed could tighten, and inflation keeps rising anyway.
The world could witness the Fed chasing after inflation instead of controlling it.
That may seem like the lesser of two evils for The Powers That Be (TPTB), but the world has changed greatly since the last time the US struggled with stagflation in the 1970s. There really was no alternative to the USD back then. The euro didn’t exist. China wasn’t on the verge of becoming the world’s largest economy.
If the Fed appears unable to control inflation, confidence in the USD would evaporate—and this time there are alternatives.
Foreigners would dump the USD in droves. The reversed flood of all the decades of excess money creation would come home to the US with a vengeance.
Whether that leads to hyperinflation or not I don’t see as certain. Some latter-day Volker might come along and try to save the day… but I rather doubt it. TPTB would never appoint such a person. And he or she might get lynched if they did.
At any rate, it wouldn’t take hyperinflation to dethrone the dollar. Loss of confidence if the Fed loses control of its Rube Goldberg USD contraption would result in a massive devaluation of the dollar. That’s all it would take.
If that does result in hyperinflation, it could trash confidence in other fiat currencies. It could be the beginning of the end for the whole idea of paper money.
I could write a novel full of fantastic images of what a post-dollar world might look like. No time for that today. And the implications for gold, silver, and all real assets are obvious.
My point is simply that it’s possible for the USD to lose its reserve currency crown. And a world in which the USD is no longer king may not be that far off.
That’s something all investors—every working person, really—should think about.
Caveat emptor,
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