Recently, I have been reading about the impending collapse in the US dollar. The arguments supporting said collapse are compelling, when you take them at face value. However, when you take a step back, you can come to a pretty stark realization: the dollar has been collapsing, for lack of a better word, for a very long time.
Currencies are nothing more than a medium of exchange and, arguably, a store of value. Today, there isn’t a better medium of exchange available in the world than the US dollar. It is, and will continue to be, the global economy’s primary reserve currency until something better comes down the pike. As I type, there aren’t any truly viable alternatives, as least as far as currencies go.
As a store of value, the dollar has been something of a disappointment for a long period of time. In 1968, the year of my birth, a gallon of regular gasoline cost an accepted $0.34; the price of gold was around $39/ounce, and the median price of a new home sold in the US was $24,700. In 2015, as I type, these numbers are: $2.0242; $1,185.30, and $297,300. The underlying units haven’t changed, but, obviously, the amount of dollars needed to buy the units have. This even as the supply of all these things is higher now than it was 47 years ago.
As such, you can very reasonably argue the dollar hasn’t maintained its value all that well. In fact, particularly when you compare it to gold, you could even say its value has collapsed. But, as a medium of exchange it has been brilliant….arguably the best the world has ever seen, and I don’t mean that lightly. The US dollar greases the wheels of the global economy like no other accepted currency before it, and there are far too many people with far too much to lose to see it collapse the way the doomsday prophets are predicting. Still, they have a point.
At some time in the future, our currency will no longer be the primary foreign currency reserve. There are no two ways about it. Dominant currencies have come and gone throughout history, and there is no reason to think ours will be any different. There just has to be something to take its place, and what will that be?
Given the sheer size of the global economy, there are only two potential alternatives as I type: 1) the euro, and; 2) the Chinese renminbi/yuan. The former has some pretty well known issues of its own, what with Greece and the rest of southern Europe giving it the fits. At some point, it will break up, if for no other reason than the Germans tire of propping up fiscal basket cases along the Mediterranean Sea. Once it breaks up, the euro will not be large enough to be the dominant global currency, particularly if the British don’t become part of the group. That leaves us with the Chinese, and whatever is behind Door #2 when it comes to its overall financial system. Shoot, its currency isn’t even convertible. So, how does it go from illiquid to primary reserve currency in such a short period of time as to precipitate a wholesale collapse in the US dollar?
No one has been able to answer that for me.
Then there are those who will suggest a basket of currencies might take the place of the dollar, something akin to the IMF’s SDRs (special drawing rights). However, the problem with that is SDRs are comprised of primary reserve currencies, as defined by the IMF:
“Today the SDR basket consists of the euro, Japanese yen, pound sterling, and U.S. dollar. The value of the SDR in terms of the U.S. dollar is determined daily and posted on the IMF’s website. It is calculated as the sum of specific amounts of the four basket currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market.
The basket composition is reviewed every five years by the Executive Board, or earlier if the IMF finds changed circumstances warrant an earlier review, to ensure that it reflects the relative importance of currencies in the world’s trading and financial systems. In the most recent review (in November 2010), the weights of the currencies in the SDR basket were revised based on the value of the exports of goods and services, and the amount of reserves denominated in the respective currencies that were held by other members of the IMF. These changes became effective on January 1, 2011. In October 2011, the IMF Executive Board discussed possible options for broadening the SDR currency basket. Most directors held the view that the current criteria for SDR basket selection remained appropriate. The next review is currently scheduled to take place by the end of 2015.”
In other words, the US dollar is still the dominant world currency even in a world of SDRs for international payments. As such, the dollar still rules supreme, even if indirectly, and will continue to do so until the Chinese open up their currency for full convertibility AND its financial system to international scrutiny. It is anyone’s best guess when the Communist Party of China will agree to such things, particularly since doing so will crush its export driven economy (due to massive demand in the global currency markets driving up the value of the Chinese currency, making the country’s exports less attractive). However, a lot of folks think this is coming sooner rather than later.
Still, this isn’t something the Chinese will throw on the international markets by surprise. Investors will have a lot of time to prepare for any such move, particularly US investors. We will likely have more than enough time to increase our gold and international allocations. Heck, silver and individual currencies will likely be in the offing as well. That is the beauty of the US dollar: it is highly liquid, and you can buy just about anything you want with it. Further, the guys with the biggest guns refer to it as: legal tender for all debts public and private.
All of this is a long winded way of saying, there might be a day of reckoning for the US dollar, but that doesn’t mean we will suffer the economic Doomsday many are predicting. Heck, the British pound was the world’s dominant currency for a century or more, and the UK has a pretty decent standard of living and way of life, even if it no longer enjoys global economic hegemony and the road wasn’t always smooth…the 1950s were particularly difficult. However, the British got through it, and so will the Americans….when the time eventually comes, which it will.
Again, currencies are used for two things: 1) as a medium of exchange, and; 2) as a store of value. The US dollar has been pretty bad at #2, and awesome at #1. It will continue to be awesome at #1 until the Chinese decide they want to take on that responsibility, and they won’t want to do so until their domestic economy is more geared towards domestic consumption and services, and away from exports…..we have more than a few years left, which is and will be enough time to adequately prepare and diversify. After all, for all its economic strength, close to 40% of China’s population still lives and works on farms, and the per capita income is roughly on par with the Dominican Republic, and well below that of Mexico. Yes, you read that correctly, and it underscores the problem with China providing the global economy with liquidity….it just ain’t ready yet.
Finally, what about gold? That can be used to facilitate trade, right? Well, sure, but gold is too cumbersome for today’s massive international transactions, let alone the tremendous volume of them. Further, if the rest of the world demanded the US either pay in gold or back the dollar with gold, we would simply require the rest of the world to do the same. This would lead to a surge in demand for the shiny stuff, because a lot of monetary authorities simply don’t stock it any longer. For instance, according to the World Gold Council, only 1% of China’s foreign currency reserves are in gold. Japan keeps about 2% in the stuff. The Swiss come home around 7%; the British about 10%, the Saudis and Mexicans are also at 2%; the South Koreans store away 1%; the IMF says the Brazilians are also around 1%, and the Canadians don’t even have that much. So, you can imagine what would happen if the US said: “okay, we will pay you in gold certificates, but you have to pay us the same way.” Let’s just say the rally in gold would be on, and it would be very easy to imagine gold prices surging 5-10x. Why? Because the central bank demand for gold to back the massive global monetary base would be probably as great as the amount of gold in existence.
And guess who owns the most, at around 261.5 million troy ounces? If gold rallied to even $5,000/ounce, which I think would be on the low side, the US would have, get this, $1.3 trillion in gold reserves alone, which would be more than enough to keep the dollar from collapsing outright and overnight, as the doomsday prophets seem to suggest. So, time is on our side there as well.
In conclusion, yeah, the dollar won’t always be the world’s primary currency reserve, and some bad things could happen in the domestic economy when the shift occurs. However, that is still some time away, and the prospect just doesn’t keep me up at night…nor should it you.
The opinions expressed within this report are those of John Norris as of the initial publication of this blog. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders, and employees.