I always figured the U.S. dollar would lose reserve-currency status because of a debt crisis or maybe a Federal Reserve blunder. Turns out the most likely reason is Donald Trump's belief that the climate is just fine without human intervention.
As Trump now pulls America out of the Paris Climate Accord, we, as investors, must stop and think about the knock-on effects. Maneuvers as meaningful as this one do not occur in a vacuum. They have consequences. Those consequences might not be so apparent early on, and they might require some dot-connecting, but they are there.
And one of the most troubling is the potential for the dollar to lose its much-vaunted status as the world's currency.
For that reason, I would now have permanent exposure to the euro, the Swiss franc, the Swedish krona, the Danish krone and the Singapore dollar. Over time, money will flow out of our greenback and into stable currencies with decent economics supporting them.
For now, though, here's the road map to how this might play out:
Eight Steps between Reneging on Paris Accord to the Loss of Reserve-Currency Status
- Trump pulls America out of the Paris Accord, pissing off Europeans who, as a culture, tend to be less insular in their beliefs than are Americans as a group.
- European leaders will have a hell of time supporting the American agenda, pretty much across the board, because their constituents, aggrieved by Donald Trump's myopic belief system that puts the planet at risk, will not cotton to any leader who supports any Trump agenda.
- Trump wants to renege on the Iranian nuclear deal. Europe does not. If Trump pulls out, he's not likely to find much (any!) support for such actions among European leaders. Many European citizens and companies support the Iranian deal, and are welcoming Iran back into the global economy.
- European companies continue to set up shop there, and they are not likely to end that quest just because the American president - whom they loathe! - wants them to. So, they will continue to work with Iran, despite any sanctions that Trump America imposes.
- Opponents will say, "Ah, but the U.S. Treasury Department can ding those European companies by limiting or curtailing their access to dollars," just as the U.S. currently threatens with foreign banks that don't play by the rules of the Foreign Account Tax Compliance Act (Fatca).
- Which brings us to the real impact of the decision to pull out of the Paris Accord: Europe at that point could very easily say, "Then we're done with the dollar. Everything will move through the euro instead." Europe will not continually subvert its economy and its moral belief system for a president that has shown such disregard for Europe.
- Other countries that are just as miffed at America for any of long litany of reasons would likely join the campaign. They'd begin trading outside dollar.
- In effect, much of the world would shed its dollar dependency and the buck would lose it's reserve-currency status.
Yes, there are certainly hurdles to overcome, since much of the world's commodities, including oil, are priced in dollars. But where there is a will - particularly a will fueled by animus - there is a way. Europe integrated more than a score of currencies into a single one (yes, with difficult and flaws), so there is clearly a capacity to change the way the King Dollar system works.
And that's where it gets really interesting here at home…
Reserve Currency = "Exorbitant Benefit"
Most Americans don't give any thought to the concept of "reserve-currency status" or the benefits that accrue to them. As I noted above, we tend to be very insular as a country, and the dollar has been atop the world for so long (since the Bretton Woods Conference in 1944) that we just assume the way it is today is the way it always has been and always will be.
But history is the ongoing story of unexpected change.
Rome never thought its empire would die. Britain never expected the pound to lose global hegemony. The Soviets never expected their socialist union to dissolve. And yet…
Years ago, a French finance minister exclaimed the America's reserve-currency status was an "exorbitant privilege" for Americans. He was right. While there are certainly burdens that come with the status - such as having to serve as central banker to the world and lender of last resort - the benefits have been a huge boon to the American economy and the American consumer over the last many decades. Consider:
- The world must keep a supply of dollars on hand. That keeps demand for the dollar high, which keeps the value of the dollar stable and strong, meaning we don't pay as much as we might for all the foreign-made goods we scarf up at Walmart (NYSE: WMT) and Target (NYSE: TGT) and Best Buy (NASDAQ: BBBY), etc.
- Because of that global demand, we don't have to acquire the money as a country before we go buy something. Other countries ship their goods here so that they can acquire the dollars they need in their trade elsewhere. So, we can more easily live on credit … or we can just print the dollars we need to buy what we want.
- That also means lower borrowing costs for America, which keeps interest rates here at home lower than they should be on houses, cars, lines of credit … or for the government's outrageous borrowings.
- It means, as well, that the food we import is cheaper, so that Americans can afford apples from Chile off season, vegetables from Mexico that aren't grown in abundance here. Bananas from all over the subtropical world. We can afford wall-sized TVs produced cheaply in Taiwan and refrigerators made in Mexico
- Because just about every major and minor commodity in the world is priced in dollars, we face no currency-conversion costs that would raise prices on just about everything we buy, even many domestic goods since so many of them rely on imports of foreign-sourced commodities.
- Along those same lines it means the gasoline we Americans pump into our cars is far cheaper that it should be.
In short, the dollar's reserve-currency status has allowed America to live beyond her means.
Which, conversely, means that if reserve-currency status evaporates, our lives get dramatically more expensive - and very quickly.
The Downside of King Dollar's Death
To be sure, there are myriad factors that define the dollar's direction over the short- and medium-term. The three most obvious are the Fed's actions vis-a-vis interest-rate normalization; the European Central Bank's pending efforts to address a better economy in the eurozone; and whatever policies Trump pursues relative to his talking and tweeting about trade and tariffs.
As I wrote recently, I still believe the Fed might not be as likely to raise rates the market presupposes. I do, however, believe the ECB is far more likely to raise rates the market currently expects, given that the EU economy is faring well and I believe the US economy masks a variety of underlying weaknesses. As for Trump - that's an unknowable wildcard. Any effort to destroy America's trade infrastructure, assuming he pursues such a path, will have debilitating impacts across the economy and would certainly weaken the greenback.
All of those, however, are short- to mid-term observations.
What I'm talking about here is the longer-term, fatalistic effect of dumping the Paris Accord, a move that might very well prove to the straw the breaks Europe's patience with Trump.
I recognize my scenario is fantastical to some. But it is certainly not pie-in-the-sky, given the enmity with which Europe views Trump and the growing desire to jab back at him in a painful way. As such, there's some probability that something very similar to what I've laid out actually unfolds in some similar way. And if does, god help the American consumer.
As I've pointed out ( here and here), the U.S. consumer isn't the model of prudence and fiscal strength. She's an over-indebted basket case, pretty much living check to check and one mishap away from ruin.
Here's a sampling of what we face as U.S. consumers if and when the dollar loses its reserve-currency billing:
- Oil prices rise, which means gasoline prices hit wallets much harder.
- Borrowing costs go up, which crushes home sales or, more likely, forces home prices lower to match a borrower's reduced ability to pay.
- Elevated borrowing costs would also topple car sales, likely leading to layoffs across the industry, which would…
- Tank consumer sentiment, which is inextricably tied to Wall Street, which mean stock prices would tank.
- Meanwhile, prices would escalate quickly for everyday products, food and consumer electronics, pinching the already indebted consumer's ability to afford their life. We'd likely slip into a deep and prolonged recession, if not depression.
- And through it all, DC would be hard pressed to do much because borrowing costs will rise on American debt, which could get quite ugly. We're more than $20 trillion in debt (and more than $120 trillion when including the off-balance sheet items such as Social Security and Medicare). Some portion of that debt rolls over continuously, meaning that as borrowing costs go up, the interest rate carried on newly issued debt goes up. That will force D.C. into hard decisions on what to fund, what to defund … or it will force politicians to take on more debt, just to pay the added borrowing costs, and suddenly America is in a debt spiral that rips through the economy and jobs and consumer wallets.
And those are just the outward, obvious affects. There exists an unknowable number of knock-on effects including whether foreign companies choose to locate factories here, or whether U.S. firms decide to operate elsewhere. All have potentially debilitating impacts on the economy and us, as consumers and investors.
Certainly, none of this will be immediate.
All of this will all play out over time. And, of course, there's no guarantee my analysis is right. But I'm willing to bet that Trump's decision to vacate America's promises in the Paris Accord will have long-lasting and knock-on effects that he and his team have not contemplated.
So, again, I will say that this is a moment to begin building permanent exposure to other currencies. If something like my scenario plays out and the dollar is the ultimate victim, you need something to buffer the losses that will accrue, and which helps to insure your standard of living.