This seems to be the weekend of currency collapse discussions.
Many of the comments and links have been well-thought cases for a cascading collapse of the US Dollar as global reserve, with arguments for its replacement with gold and/or silver.
One poster even suggested that digital ownership and transfer of bullion can overcome the perennial problem of weight, cost of transfer, and the concentration issue that arises from trade imbalances.
Let me throw my nominee into the ring, and explain why I think there won’t be the spectacular “break” so many are predicting, followed by a post-apocalyptic financial landscape.
Before I forget, the reason I call this a “spoiler alert” is that it floats one of the dozen or two ideas George Ure and I are kicking around in our upcoming book of economic and investment ideas for sentient adults who see that things aren’t going according to plan.
To put it in the proverbial 25 words or less, the US Dollar may be approaching its denouement as the single reserve currency for world trade. I’ll suggest a potential replacement path that doesn’t take a detour through a Hieronymus Bosch painting.
You can argue (endlessly) about why the Dollar can’t take the stress, and you’ll no doubt stir up some hot partisan political rhetoric doing so.
I’m not interested. For example, I don’t don’t think it matters one bit what politicians in the US say about acceptance of our currency by trading partners overseas or its use as a reserve by central banks. In point of fact, there is nothing they can do about the choices of private companies or foreign countries when they decide how to be paid for their goods and services.
I’m more interested in how the system may evolve toward another paradigm.
I think there may well be a transition to currency baskets, as that is already in process among global trading partners in deals we are not a party to. It’s only a matter of time until global oil trade, soft commodities and the world of Letter of Credit supported trade of all types shifts, in part, away from the dollar.
But to what? The Euro is a mess. The Yen is still feeling the doldrums of the Lost Decade (and counting), and the Asian Tiger economies are simply too volatile and small to support currencies that will work for any amount of time with global trade the size it is.
The intermediate answer is likely to be a basket of currencies.
But that still leaves the “fiat currency” issue, and nearly every central bank is creating liquidity like mad to counteract ever-slower economies burdened with cyclical slowdowns plus policy-driven austerity. More than one person, company or country loading up its bulk carriers, tankers or container ships may feel that a portfolio of weak currencies is really no better than just one.
So why not gold?
Because the big issue that made the Great Depression go global was the fact that reserves were drained on one side of the Atlantic to meet obligations on the other side. Unbalanced trade has no way to re-balance if the medium of exchange gets delivered until one party to the relationship looks into the vault and finds it empty. At that moment, trade stops.
The US Dollar (so far) has had a means of balancing the books, by the mechanism of debt issuance.
I know that’s anathema to the “hard money” advocates, but I think they haven’t thought about what happens once all the chips are on one side of the table. They think that as long as they have some of the new “chips,” they’ll be OK. I beg to differ. If a few billion people have nothing to lose, they will tend to do drastic things, things no one wants to see happen.
And before you say that prices will adjust and the chips won’t end up on one side of the table, think again. If the domestic pressures are high enough, governments will ignore the peril to their reserves and keep buying the commodities their people require. Think cooking oil, rice, crude oil or wheat. If the choice is to fall out of power or keep the people fed, Prime Ministers and Presidents in any political system will keep on buying as long as they can.
Just look at history to see what I mean. Even before America revved up its war machine for World War II, it was an overwhelmingly large opponent for the Empire of Japan. Their military was already overextended in China and the rest of Asia. Still, they felt they had no choice but to attack Pearl Harbor because America cut off their oil supply.
We would be kidding ourselves to imagine that any global financial system that always required payment vs. delivery wouldn’t engender just these kinds of problems in the future.
Why do you think the debt-based system has lasted this long? Because nations have the ability to tax their citizens, extract resources, or earn exchange credits in some other way. Until the debt got so large that it became clear some nations couldn’t pay, that worked.
So let’s not go to the simplistic solution of only trading C.O.D. That almost certainly would lead to a drastic decline in global GDP, a decline so large that a big percentage of the people on the planet might not survive.
Let’s look at backing currencies with something of value because of its utility. Let’s consider doing so with renewable wealth. I pick energy in all its forms, since we already know the physics formulae to convert KWH, BTUs, BOEs, etc into each other.
But wait! What about Peak Oil? Sure. But there’s coal, natural gas (fracked), nukes, hydro, solar, wind, tidal power, geothermal, and maybe some day deep ocean methane or oil-producing algae. In one sense, all but nuclear power is just solar power with up to a hundred million years of delay.
The good news? The sun will keep sending us new energy for another few billion years. As we get better at catching it, storing it and using it in all its forms, we’ll be able to grow our usable supply of energy over time, and grow our economy. Maybe we’ll even keep up with population growth.
My favorite part of this plan? If you need to take payment from your counterparty, it will be very useful to you, something you can’t say about their fiat currency, or their $5,000 an ounce gold. Basically, unlike Rooster’s well-argued currency idea that requires non-economic value to work, this actually bases itself on a set of deliverables that can be used by the recipient to do more than trade onward for something else.
By the way, one of the issues that may be raised is the idea that the currency would vary too much. Too much for what? Even if it varied as much as a barrel of oil (which careens around far more than capital-cost-derived kilowatt hours, for example), the variability is not too much more than currencies themselves. And for those who prefer gold — fuggedaboutit. 600% in one decade? So maybe the convertibility sets a floor value. Interestingly, that may work out well, since currencies tend to fall when an economy is weaker, which is also when the price of energy components tend to fall.
I should make it clear that I believe the participants in the market will decide what to trust in their money and trading, and I believe that no politician can dictate those terms, especially for others. On the other hand, it might make sense for countries to take actions that make their currency more attractive.
I don’t kid myself that this (alone) would stabilize the world economy, or that there wouldn’t be the normal variance caused by supply and demand during business cycles. I’m just saying that countries who agree to back their currencies with energy units might find themselves enjoying the benefits (acceptance of debt at lower interest rates, for example) that comes from being a reserve currency.
I’m not saying we’ll get rid of currencies, or bank accounts, or central banks. I’m saying those work for what we need them for — daily commerce with minimal friction. We need the divisibility, ease of transport, and fungibility that currency gives us.
But if we get to a place where the world needs backing for currencies, given the fiscal imbalances in the US, Europe and Japan, I think converting currencies into BTUs might be the way to go, since even when the cupboard is bare, petrochemical extraction, solar collection, hydro power, etc. can replenish that cupboard. That might even satisfy the “audit the Fed” crowd, assuming they’ll believe that Bonneville Dam will still generate electricity tomorrow and the next day. Layer in some debt to handle cold winters or cyclical downturns, and you might have a system that could survive the next couple of centuries.
By then, there will be new problems, but they will be somebody else’s to solve.