US Dollar: "I'm Not Dead Yet!"

Analyzing currencies is weird, and most people don’t get it. Sometimes, I think I don’t get it. There is nothing fixed in our economic world, no fixed measure of value. Everything trades against everything else. Currencies exist to make the trading easier. Imagine a matrix that is millions by millions, with trillions of exchange rates for one good or asset against another. With currencies, it simplifies. Each nation prices out goods and assets in their own currency, and then currencies trade against each other, subject to arbitrage with commodities, and commodity-like assets.

Anyone who has read me for a while knows that I am not a bull on the US Dollar. But where I part ways with the grizzly bears (call me a teddy bear ), is that the fundamental accounting identities must be maintained. Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.

It does not matter what currency crude oil trading, or any other trading, is denominated in; it does matter in what currency the proceeds from the sale of crude oil is invested in. So long as the US runs current account deficits, foreigners must acquire US assets in order to fill in the gap. In the past that has mainly been bonds — agency, mortgage, corporate, but increasingly Treasury notes.

It is not that easy to abandon the US Dollar. Where do you go? The yen will suffer for years as Japan heads into demographic decline and large structural budget deficits. The Euro is still an experiment; there are many pressures on it; its survival is not assured. Nothing else is large enough, stable enough, or mature enough to run the deficits necessary to have the debt markets, to be the global reserve currency. As an example, China does not want to run deficits, nor is its financial system strong enough to bear the wear and tear of global use of its currency.

So, when reporters write pieces indicating the imminent demise of the US Dollar, I don’t buy their arguments:

• The demise of the dollar
• The latest dollar rout revealed

Other parties disagree with the worry:

• Oil states say no talks on replacing dollar
• Saudi Arabia Denies Holding Secret Meetings To Kill The Dollar

If the money is not invested in US Dollar investments, where will they invest? That is the question.

Now, there are other issues. China could queer global trade by asserting that entities in China could default on obligations from derivative contracts and not worry about it. Why is this big? If a major country does not respect contract law, that country will not be respected in global trade. Granted, China is a creditor, not a debtor on net, but the ability to transfer capital is paramount in the global economy, and if China will not honor contracts, that will bite them.

Away from that, I was fascinated by Australia’s interest rate hike. It makes me bullish on the Australian Dollar, even after its significant rise. That said, don’t move too aggressively, because eventually US Dollar rates will rise.

My view is that the US is in a Japan-like funk, which it will not rise out of for years. I don’t think the Fed will move aggressively — they will be timid. It is easier to argue to Congress that they did their best but conditions were severe, than to argue that they headed off inflation, but many people were unemployed.

Unless Europe moves to a full political union, or China frees its economy, there is no real competitor to the US Dollar. Yes, the dollar will likely decline over the next decade, but it will not be likely to lose its reserve status, unless a commodity standard currency comes into being.

Comments

[Arthur Hau:]

A currency can never "die" unless there is uncontrollable hyperinflation!

Once the interest rate in the U.S. rises to its normal level comparable to those of its trade partners, the U.S. dollars will become strong again.

One of the major mistake committed by the Obama administration is that despite the current low interest rate and trade deficit against China, it is incapable to force China to appreciate its currency to a more reasonable level.

Well, this perhaps can keep inflation rate low because otherwise there may be import inflation. However, in the long or medium term, the trade deficit will only worsen and serves a major drag to the economic recovery of the States.

Please, Mr. Obama, the U.S. needs stronger international trade policies, not the elimination of pre-existing conditions in health insurance. The latter only serves to raise premium rates and leave even more Americans uninsured!

Oct 07 01:19 PM

[jimmy46:]

Too many people don't understand the immense amount of respect a currency must have to become a "reserve currency",
and once that has been attained how long it carries.
It took the US 150 years to become a reserve currency,
upstarts can't expect a shorter testing time.

AND, MOST PEOPLE SEEM TO HAVE FORGOTTEN THAT THE BRITISH POUND IS STILL A RESERVE CURRENCY.

DURING THE 19th CENTURY THE POUND WAS THE MAIN RESERVE CURRENCY, AFTER BEING BLED WHITE BY 2 WORLD WARS IT BECAME A MUCH POORER COUNTRY, ONLY REVIVED BY NORTH SEA OIL & THATCHERISM,
BUT IF PEOPLE WANT A CHOICE, THE POUND IS STILL HERE.

AND WHY?
BECAUSE THEY HAVE NEVER DEFAULTED ON THEIR DEBTS,
NOT 2 WW's, NOT THE DEPRESSION, THEY'VE HUNG TOUGH, AND PEOPLE HAVE RESPECT FOR THAT.

THE DOLLAR IS MUCH MORE IMPORTANT AS A RESERVE CURRENCY AT PRESENT, BECAUSE THE U.S. PRINTS MORE DEBT THAN BRITAIN.

Oct 07 01:31 PM

[eggfaced:]

So the dollar will have a nice slow decline????

This makes no sense whatsoever, why would you hold an investment whose value you know is going to deteriorate? Would you buy a stock that is going to slowly go bankrupt over the next 10 years? Central banks and citizens of the US and other countries are starting to realize this and are dumping their dollars at an alarming pace. There are plenty of alternatives such as any real asset; stocks, oil, and metals. China is diversifying away from dollars and buying up oil fields and mines like crazy. Any hard asset is a viable substitue for dollars. Gold especially because it is the only true currency and can be stored and traded with relative ease. Don't be fooled by people who say there is no substitute so people have to buy dollars. They don't and there is going to be a severe run on the dollar very soon.

Oct 07 01:41 PM

[Dr. O:]

I think the US Dollar, in a sharp decline since 2000, is being replaced not by one currency, or one commodity like gold, but by a diversified basket of other stores of value. Oil, gold, rice and copper; other currencies like the Euro, Yen, Loonie, Aussie, and Real; and stocks, and real estate, etc.

The dollar has lost nearly half its value versus the Swiss Franc in 2000, and about a third of its value relative to the Euro.

Oct 07 02:54 PM

[muellship:]

Look for trends in the interaction between emerging economies (especially China) and U.S. monetary policy over the past 20 years. Who is leading whom? The Chinese have been slowly amassing money and investing it in dollars; as their stake has grown, so has U.S. borrowing of easy money 2 stock market gold rushes (1992-2000 and 2003-2008) . Chinese progress has driven up the cost of all commodities. Then we have the crash of 2008 and all the hedge funds sold off their commodities at fire-sale prices. Meanwhile, the cash rich Chinese gobbled up these commodities as fast as U.S. fund managers could unload them. Now we have a run up in commodity prices and Chinese investment in domestic infrastructure which indicates that they might no start spending this money at home and developing their economy from the demand side. But what about these now again expensive commodities and all those Chinese T-Bills that are depreciating in value? If I were China (and make no mistake, the ball is in their court, we are just too naive or arrogant to accept it) I would maneuver for another crash that necessitates a flight to safety (still the American Dollar and Yen (but less so the dollar, now that we have all these dollars floating about and in bank vaults and a negligible interest rate). Then all these people/funds who gobbled up commodities on margin and neeed to cover their positions sell off; then the commodity price drops and the dollar gains and viola! We have another fire-sale on commodities so the Chinese can unload more of their (now more valuable) U.S. dollar. Then expect a cycle of these boom busts but at lower amplitude as the dollar continues its inexorable slide to worthlessness.

Oct 07 03:00 PM

[Bob Mayo:]

Can anybody comment on the depth of the forex markets? Could, say, China have 25% of its reserves in euro, and then simply convert at the last minute to $ to buy oil, with the oil producer converting back to euro if they wish? What's magic about pricing oil in dollars when currency is easily convertible?

Oct 07 03:19 PM

[carey_jim:]

The value of a nation's currency is determined not only by economic factors but by cultural and historical factors, which is another way of saying that economics rests on more than simply the amount of goods and services exchanged by a nation's citizens.

If we look at the history of European unity we see that, for example, the Spanish Empire was definitively displaced by the American Empire with the defeat of Mexico in 1845 and the annexation of the Western United States. After that, Spain never succeeded in becoming a truly unified empire. In the Spanish mainland, at least four language groups, including Spanish, exist along with their independent traditions. Until recently, after the Civil War of the Anarchists, the only force capable of holding anarchist Spain together was the military dictatorship of Franco.

Italy is also divided into incompatible regions and usually wavers between de facto dictatorship (Berlusconi) and anarchy (rule by family and mafia.)

Both Germany and Italy only became countries in the late 19th century and Germany, after a long history of a patchwork of dictators and republics, is still a patchwork of dialects and loosely connected regions and traditions which include Austria, Switzerland, East Germany and West Germany and the regions each country contains.

Compared with the United States, France has been in a state of anarchy since the defeat of Napoleon and has been described by one of its leading sociologists as a Blocked Society, constantly at war with itself and its own interests.

After factoring in Germany's disastrous early 20th century history, it is not easy to believe that the Euro will become a world currency because it is far from clear that Europe CAN unify, not to mention whether Germany, Italy, France and Spain can unify themselves.

America represents Anglo-Saxon civilization which has dominated the world in the form of the British Empire since the defeat of Napoleon. The American Revolution placed America in a position to exploit the massive resources of the North American continent and to surpass Britain itself in economic output by the beginning of the twentieth century.

World War I and II weakened Britain's colonial empire and, to Britain's shock and humiliation, gave America the opportunity to take over Britain's role as ruler of the world, which of course we did. After the defeat of communism, America has had no other rival or enemy on earth OTHER THAN HERSELF.

It makes no historical sense to think that a currency of one of our former mortal enemies, Russia or China would be able, and much less allowed, to take on the role of a world reserve currency.

America is now the leader of the civilization "inherited" from the British and it includes England, Ireland, Scotland, Wales, Canada, New Zealand and Australia, not to mention other English speaking parts of the world such as South Africa.

America has lost its "spiritual" way which can (very briefly) be summarized as individual liberty combined with equal opportunity for advancement of all ("the pursuit of happiness.")

The American plutocracy has closed its ranks and has barely noticed the resulting impoverishment of the ordinary American below, and the shrinking of the American middle class.

The rest of the world is observing us closely and preparing for what looks like a perfect American storm. What form this storm will take is impossible to predict.

Oct 07 05:17 PM

[ryanclarke:]

You wrote, "The yen will suffer for years as Japan heads into demographic decline and large structural budget deficits." ... and thus the U.S. will still remain the world's reserve currency. Not according to the Euro nations, Mr. Merkel. And Russia, economically, is in a far better position than most Americans think. The Russian economy is a net exporter of oil and gas ... and the Euro nations need that oil and gas. What's happening right now is the world waking up to the fact that California's tech gizmos haven't improved much since the late 1990's but the United States thirst for foreign natural resources hasn't abated in the slightest in ten years. The ability to "transport" via use of "hydrocarbon explotation" has until recently been assumed to be practically free in terms of dollars. Now, unless the U.S. can produce new technology to demonstrate such is the case, you can rest assured the world is going to reprice the dollar.

Oct 07 07:53 PM

[E Nuff Sed:]

I agree with author. The reserve status of the US dollar is not going any where for at least another decade, but it will be consistently devalued. I don't think reserve status or relative value are related concepts.

For foreigners US assets now offer compelling value. The best bargains are dividend paying US based global companies like P&G, JNJ, BA, MSFT etc. They are priced in USD but do a majority of their business globally (and the international portion is growing much faster than the domestic portion).

Oct 07 08:09 PM

[Past Tense:]

An excellent submission, I'd also like to add that as an Australian we need a strong America, not just for the obvious security blanket they provide to the decent people of the world, but also the innovation they bring to the world. America did not copy Japan when it built the first production line, nor did they import goods and 'deconstruct' them for state sponsored enterprises to copy. They have not 'pegged' their currency to another in order to artificially create surpluses. The world including China, Russia and other 'critics' need the yanks healthy and strong (more than ever before - economically, politically, culturally and militarily).

Finally, gold has rallied but not much in $Aus terms. A far better investment since march was our very own over sold stock market. Gold provides a store of wealth (or so I'm told) but what it seems to do as far as I'm concerned is provide a hedge for those citizens in countries which have serious concerns about their own currency (inflation or deflation) and little else, economic recovery usually sees it returned to Grandma's jewellery box. Our communistic capitalist friends have bought other more useful hard assets, I wonder which will be more useful in the long run.

From a personal viewpoint, I'm getting a little nervous about our $Aus, the certainty that the $US is heading for the abyss, and that Gold is the answer. Buffet, Gartman, Soros, Rodgers and co and all seem to have some sort of contrarian saying which loosely plagiarised means 'if everyone is certain that a trend will continue then I get nervous and out'.

Oct 07 10:42 PM

[ebworthen:]

But will the Dollar turn into a Newt, then get better?

Oct 07 11:16 PM

[derryl:]

There is an alternate reserve currency available, gold. But returning to gold would prevent the kinds of prolonged trade imbalances the US has been enjoying, and that China has been using to build up its industrial infrastructure. If imports must be paid for in gold, then you run out of gold (run out of importing power) if you try to buy and consume more than you produce and sell for too long. Then rather than buy more you have to produce and sell more in order to get some gold back in your treasury. Structural trade imbalances become impossible to sustain under gold.

The US could not finance its military, plus afford its world leading standard of living, under a gold regime. David makes the point that any country whose currency functions as the global reserve currency must issue a lot of debt in order to put enough money out there for the global economy to use. So the US can finance its military and standard of living while doing the world the service of providing it with a reserve currency, all built on money that was created in the US as debt.

This debt-money global reserve currency system could go on indefinitely, but because US private and public sector borrowers are reaching their debt ceilings there would have to be a new policy of issuing free money to Americans that they could use to liquidate some or all of their debts. The old debt-money would still be out in the world, and the new money would be used to repay the loans and uncreate both the free money and the old debt.

Without continuously accelerating growth in the issue of new debt-money as bank loans, the modern monetary system eventually collapses into deflationary depression like we're doing now. The solution is to liquidate a lot of the debt without simultaneously removing all the money from the economy which is what happens when bank loans are repaid in the normal way. The only way to accomplish this, besides mass bankruptcies with debt writeoffs and deep, long depression, is to create and distribute free money.

This is not a moral issue. It is an arithmetic issue. I think David is right that there is no other country whose currency could fulfill the global reserve function. The "currency basket" idea could technically work, but how long do you think a half dozen diverse nations will "agree" on global monetary matters? We're basically talking about a business partnership type arrangement, where each of the partners has interests that clash with the interests of the other partners. Not a recipe for a stable monetary regime. If we're going to use somebody's money, it will be America's.

I think the world will eventually return to a gold standard, but hopefully I won't be alive to see that day. I say "hopefully" because gold will be the last grasp effort to stabilize a dangerously chaotic global currency situation that will have been spinning out of control for some time before nations will accept the discipline of gold. When that day comes the currency carts will trundle through the nations with their drivers shouting, "Bring out your dead currencies!" Some will claim, "But I'm not dead yet.", but by that time we'll know the deniers are on their last legs and we'll toss them on the cart with the rest.

Oct 07 11:16 PM

[surfgeezer:]

Well David, I disagree and would like you to explain
" Whatever country of our world has the status of reserve currency must issue debt"
I in fact factor debt as a negative when making currency trades and do not see the connection between reserve currency status and budget deficits, other than it is easier (less interest cost) to fund the debt.
I do agree-"It does not matter what currency crude oil trading, or any other trading, is denominated in; it does matter in what currency the proceeds from the sale of crude oil is invested in."
In fact a major part of being a reserve currency is the stability and who would choose to invest in a negative investment, unless of course you wanted to keep your currency artifically low. A trading partner does not have to keep the profit anywhere, they may choose to as a way to keep their prices relatively low but the cost of not keeping it at home is a loss of capital for investment at home.

Oct 07 11:43 PM

[Morrison Bo...:]

The world AND the U.S. will be better off when the U.S. Dollar is replaced by, and incorporated into, a Single Global Currency, managed by a Global Central Bank within a Global Monetary Union. In Europe, countries are using one currency. Why not the 192 U.N. members?
We don't need to wait for the further decline, and perhaps rapid decline, of the dollar to start planning for the Single Global Currency.
The primary problem with the euro and currencies of other monetary unions is that they still must co-exist within the international multi-currency system itself where the value of those common currencies must still fluctuate in value against each other. With a Single Global Currency, there are no such fluctuations, by definition.
In addition to eliminating currency fluctuations, the use of a Single Global Currency would eliminate the current foreign exchange trading expense of $400 billion annually, eliminate currency risk, eliminate current account imbalances, and eliminate the need for foreign exchange reserves.
With a Global Central Bank with a primary goal of monetary stability, inflation would likely be lower.
The world should begin researching and planning now for a Single Global Currency, which will save the world - literally: trillions. It is not a cure for the current recession, but will help lay the groundwork for a more stable future.
The Single Global Currency Assn. promotes the implementation of a Single Global Currency by 2024, the 80th anniversary of the 1944 Bretton Woods conference. We will reach that point through the creation, expansion and merger of currencies of nations and monetary unions.
That's only 15 years away. The Assn's website is singleglobalcurrency.org. See, also, the book, "The Single Global Currency - Common Cents for the World," and the ICFAI University Press book, "A Single Global Currency - Perspectives and Challenges."

Morrison Bonpasse
President
Single Global Currency Assn.
Newcastle, Maine, USA

Oct 11 09:14 PM

[untrusting ...:]

So what's a US or Japanese or any other exporter going to get paid in? 10 checks from 10 different bank accounts ( rubles, yen, euro, etc) to make up the basket of currency. And what happens when the exchange rate is changing among the currency basket every 1/10 of a second?

Of course the US dollar will remain the world reserve currency for many years to come. Until some practical concept is designed, even if that is possible, and then tested for years..... there just is no alternative to the US dollar. It may continue to decline in value and likely will .... but there is no other alternative on the horizon.


On Oct 07 07:36 AM Living4Dividends wrote:

> Nice post. I agree that the dollar will likely decline over the next
> decade. Best case scenario: nice gradual downward slope.
>
> I disagree with the "no suitable replacement" scenario.
>
> What about a mixed basket of currencies?

Oct 14 12:44 AM

[Plant the s...:]

No other currency has the liquidity to replace the dollar. Some dollars can and will go into Yen, Euro & commodities, but unless exporting countries want to attack their surpluses by depreciating the dollar.

On Oct 07 07:36 AM Living4Dividends wrote:

> Nice post. I agree that the dollar will likely decline over the next
> decade. Best case scenario: nice gradual downward slope.
>
> I disagree with the "no suitable replacement" scenario.
>
> What about a mixed basket of currencies?

Oct 14 03:18 PM

[Plant the s...:]

Back in the gold reserve days the fed only held 1/350th value of gold for the circulating currency, since then money supply has exploded, all the gold in the world will buy about 10% of the US dollars in the world, forget about Yen, Euro.

All exporting countries keep their currencies weak by buying dollars. If they want to depreciate the dollar, they will also have to deal with the loss of export competitiveness.

Japapese & Chinese do not buy US debt out of the goodness of their hearts, they want to keep their currencies cheap and boost exports.

On Oct 07 11:16 PM derryl wrote:

> There is an alternate reserve currency available, gold. But returning
> to gold would prevent the kinds of prolonged trade imbalances the
> US has been enjoying, and that China has been using to build up its
> industrial infrastructure. If imports must be paid for in gold, then
> you run out of gold (run out of importing power) if you try to buy
> and consume more than you produce and sell for too long. Then rather
> than buy more you have to produce and sell more in order to get some
> gold back in your treasury. Structural trade imbalances become impossible
> to sustain under gold.
>
> The US could not finance its military, plus afford its world leading
> standard of living, under a gold regime. David makes the point that
> any country whose currency functions as the global reserve currency
> must issue a lot of debt in order to put enough money out there for
> the global economy to use. So the US can finance its military and
> standard of living while doing the world the service of providing
> it with a reserve currency, all built on money that was created in
> the US as debt.
>
> This debt-money global reserve currency system could go on indefinitely,
> but because US private and public sector borrowers are reaching their
> debt ceilings there would have to be a new policy of issuing free
> money to Americans that they could use to liquidate some or all of
> their debts. The old debt-money would still be out in the world,
> and the new money would be used to repay the loans and uncreate both
> the free money and the old debt.
>
> Without continuously accelerating growth in the issue of new debt-money
> as bank loans, the modern monetary system eventually collapses into
> deflationary depression like we're doing now. The solution is to
> liquidate a lot of the debt without simultaneously removing all the
> money from the economy which is what happens when bank loans are
> repaid in the normal way. The only way to accomplish this, besides
> mass bankruptcies with debt writeoffs and deep, long depression,
> is to create and distribute free money.
>
> This is not a moral issue. It is an arithmetic issue. I think David
> is right that there is no other country whose currency could fulfill
> the global reserve function. The "currency basket" idea could technically
> work, but how long do you think a half dozen diverse nations will
> "agree" on global monetary matters? We're basically talking about
> a business partnership type arrangement, where each of the partners
> has interests that clash with the interests of the other partners.
> Not a recipe for a stable monetary regime. If we're going to use
> somebody's money, it will be America's.
>
> I think the world will eventually return to a gold standard, but
> hopefully I won't be alive to see that day. I say "hopefully" because
> gold will be the last grasp effort to stabilize a dangerously chaotic
> global currency situation that will have been spinning out of control
> for some time before nations will accept the discipline of gold.
> When that day comes the currency carts will trundle through the nations
> with their drivers shouting, "Bring out your dead currencies!" Some
> will claim, "But I'm not dead yet.", but by that time we'll know
> the deniers are on their last legs and we'll toss them on the cart
> with the rest.

Oct 14 03:24 PM

[Plant the s...:]

US dollar will become less important once the share of US in global GDP, Investments and trade decreases as the share of other countries increase.

Oct 14 03:26 PM

[Plant the s...:]

Part of running a trade surplus is that you end up with surplus of whatever country you are running the surplus with. You can choose keep it with 0% interest or invest it (your choice as a country) through debt of some form and get interest.

On Oct 07 11:43 PM surfgeezer wrote:

> Well David, I disagree and would like you to explain
> " Whatever country of our world has the status of reserve currency
> must issue debt"
> I in fact factor debt as a negative when making currency trades and
> do not see the connection between reserve currency status and budget
> deficits, other than it is easier (less interest cost) to fund the
> debt.
> I do agree-"It does not matter what currency crude oil trading, or
> any other trading, is denominated in; it does matter in what currency
> the proceeds from the sale of crude oil is invested in."
> In fact a major part of being a reserve currency is the stability
> and who would choose to invest in a negative investment, unless of
> course you wanted to keep your currency artifically low. A trading
> partner does not have to keep the profit anywhere, they may choose
> to as a way to keep their prices relatively low but the cost of not
> keeping it at home is a loss of capital for investment at home.

Oct 14 03:30 PM

[Plant the s...:]

Russia is projected to loss nearly half its population by 2050. Not a recipe for economic vitality. For Europeans to supplant the US and US dollar they will need to stop their petty squabbling and drop centuries old animosities.
My detailed post on Russia
seekingalpha.com/insta...


On Oct 07 07:53 PM ryanclarke wrote:

> You wrote, "The yen will suffer for years as Japan heads into demographic
> decline and large structural budget deficits." ... and thus the U.S.
> will still remain the world's reserve currency. Not according to
> the Euro nations, Mr. Merkel. And Russia, economically, is in a far
> better position than most Americans think. The Russian economy is
> a net exporter of oil and gas ... and the Euro nations need that
> oil and gas. What's happening right now is the world waking up to
> the fact that California's tech gizmos haven't improved much since
> the late 1990's but the United States thirst for foreign natural
> resources hasn't abated in the slightest in ten years. The ability
> to "transport" via use of "hydrocarbon explotation" has until recently
> been assumed to be practically free in terms of dollars. Now, unless
> the U.S. can produce new technology to demonstrate such is the case,
> you can rest assured the world is going to reprice the dollar.

Oct 14 03:38 PM