Rumors are circulating that the dollar is in danger of losing its status as a reserve currency. It is certainly a real possibility and it would not be the first time that a currency has fallen. of thanks.
The loss could be sudden and traumatic, or insidious and stealthy, but either way it would certainly impact all dollar holders. These include ordinary citizens, the international trade sector, and many of the world’s central banks whose reserves are made up of about 60% US dollars and treasury bills.
Reserve currency status has its advantages, but those same advantages also have its disadvantages. Essentially, reserve currency status allows (forces) the reserve currency country to “devalue” its currency by issuing large amounts of its currency and increasing its national debt in order to accommodate this role.
As you can imagine, getting into debt is a lot of fun. Many of us do this on a regular basis, and the US government has had a blast with it – or rather for 78 years – since 1944. The problem is that issuing money and financing the national debt creates a huge amount of credit type money. above the country’s own needs in transactions and savings, the creation of which, by definition, devalues the currency even if this reality is not immediately recognized by the national market through price inflation.
Internally, the creation of dollars to satisfy the world’s need for reserves causes US prices not only to reflect the usual supply and demand pressures in the market, but they also surreptitiously absorb additional global demand for reserve currency. Supply and demand are no longer the only voices in the finely tuned chorus that determines the overall price level. Distortions and misjudgments are bound to occur, even if prices seem relatively stable.
If the dollar were to lose its status as the world’s reserve currency, it would likely follow a path similar to that taken by the British pound almost 80 years ago: devaluation. Or more exactly, the sudden awakening of the public to an insidious and chronic, albeit hidden, devaluation.
Devaluation is usually accompanied by general price inflation before or after the revival. The British pound, for example, lost its official reserve currency status to the US dollar in 1944. Between 1935 and 2005, prices in the territory of the British pound skyrocketed by 5,000% (about 70% per year ), compared to 200% over the previous 185 years. (about 1% per year).
Reserve currency status also implies an “imbalanced” trading account. Technically, a trading account cannot be out of balance in an accounting sense. A negative trade balance is always offset by the amount of dollar instruments and dollar-denominated investments held by trading partners. However, such an imbalance can be deleterious through its unintended consequences.
Reserve currency status, some argue, destroys the industrial capacity of the reserve currency nation, as happened in England throughout the 20th century. See this article on Wikipedia regarding what is called Triffin’s dilemma.
But at some point, the Piper has to be paid. Or at the very least, dollar holders need to be confident that the United States can pay whatever it owes if it has to. Imagine that you are a baker and you promise 200 of your neighbors that you can provide them with a cake on demand. Things are going well for a while with a few dozen requests per day. Everyone loves you. But one year, on the 4th of July, you accept many orders. You need 150 cakes, but it turns out you can only produce 100. Word will quickly spread that you are unreliable.
Today, as everyone can see, our national debt is reaching unprecedented heights. How far can he go before exceeding this confidence limit? If a drop in the dollar occurs, it will happen when other nations lose that confidence. So far, no country really has any interest in seeing the dollar crash, as many of them hold so much of it in their own reserves. Japan has $1.3 trillion, China $1 trillion, the UK $608 billion, Luxembourg $311 billion and on the list of top 35 holders of US Treasury securities alone.
On the other hand, those holding dollar-denominated debt might be happy to see it fail, as they could pay off their debts in a cheaper currency. There are several, for example Indonesia ($19.7 billion), India ($18.8 billion), China ($16.2 billion), Brazil ($15.4 billion dollars), Mexico ($15.2 billion) – a total of 78 countries at the World Bank alone.
It’s hard to predict how this will all play out, but in my opinion, given the spending frenzy we’re in right now, it has to play out. In fact, China, Russia, Iran, India, Australia and other countries have already started using other currencies in their trade transactions, probably because they have observed the excessive expansion of the dollar.
The question is probably not if the US dollar will lose its unique status at the top of the list of reserve currencies, but instead How? ‘Or’ What he will lose it and when. To paraphrase the famous maxim of Keynes (or was it Shilling?), a currency can remain a reserve longer than you can remain patient. Good luck trying to predict when things will change.
What to do about it
As China, Japan and Russia continue to reduce their holdings of US Treasuries, which they began to do over the past decade, the US Federal Reserve has filled the void. But the Fed will start to scale back its purchases, or so the governors have announced. We will see what they end up doing in the current delicate global and national circumstances.
There is talk of increasing the role of SDRs to take over the role of reserve currency. SDRs are special drawing rights at the IMF, currently made up of a reserved quantity of the five most “popular” fiat currencies: US dollar, euro, yuan, yen and pound sterling.
SDRs are considered by some to be more independent and therefore more stable reserves for monetary systems. However, the IMF has been known to issue them arbitrarily, and please note that they are also based on fiat currencies, which means that collectively they are no more stable than everyone’s average stability.
In my view, if the reserve currency status of the dollar were seriously challenged, a sudden adjustment to dollar devaluation would occur during a period of price inflation such as is occurring now. The potential for a recession could also appear when interest rates rise, and the exchange rate of gold with the dollar would certainly increase, as it always has when the loss of purchasing power of the dollar is recognized.
Quite recently, the BIS (the Bank for International Settlements, which is the central bank of central banks) has increased the role of gold in the reserve requirements of banks around the world. So even though gold’s role as a monetary anchor has fallen off the radar of politicians, it remains an anchor and will likely remain so for the unpredictable future.
Logically, holding a certain percentage of your portfolio in the only real currency that has never disappeared or been devalued cannot be a bad idea. To affirm this notion, one can compare the results of investments in various financial vehicles during the last 50 years since the dollar was definitively separated from gold. A recent study reveals that US equities come first, followed by gold, outperforming foreign equities, REITs, US bonds and foreign bonds.
Considering that US stocks currently look like the biggest bubble in history, second place doesn’t look too bad. Additionally, gold is inversely correlated to most other currency-denominated investments and should therefore perform well in an environment of recession and/or dollar deflation.