The US Dollar has failed as a Reserve Currency - Mine Digital
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The US Dollar has failed as a Reserve Currency

April 8, 2020 • 
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Where to from here?

Due to social, cultural and political factors the status of the US Dollar as the worlds reserve currency, its ‘exorbitant privilege’ (according to one French Finance Minister from the 1960’s) has recently been leveraged for one of its last times. Its impending failure is an epic and unprecedented event given the globalisation of trade and the financial system.

Although it had already been the case December 2019 when $500 billion USD of extraneous liquidity was required to grease the wheels of global finance, the pressures of Covid-19 have firmly established that the remedies to the Global Financial Crises (which were also the causes of it) have created a feedback loop in the financial system where artificial funding has corrupted the system of relationships that makes things tic.

The reality is that this process, in which money is created without any connection to economic activity, any network of transactions, any men digging holes, any buildings being built has created a feedback loop within the ethereal world of finance. It is now out of the control of any man, group, organisation, institution or government. It is too complex and the power and control of those who would try to fix it too simple.

To get us into the situation was a delusion that we could tinker with a system in this way to begin with. Each outrageous precedent after another from decades ago betrayed a deep arrogance and insouciance to consequences that we think is reflected by the zeitgeist of the 90’s and 00’s.

Although the history of reserve currency handovers is sometimes referred to as ‘normal’ or ‘natural’ and even expected with the US Dollar, there is absolutely no precedent to this type of change occurring into such a complex ecosystem as the global financial system.

A Short History of the USD as the Global Reserve Currency

Although the retrospective view of global reserve currencies rationalises the US Dollar as equals alongside the British Pound or France’s Franc, this conceptualisation is a post-hoc rationalisation of the Pound, Franc and other currencies skewed by todays comprehensive domination of the US Dollar over the global financial system. In a league of its own, the US Dollar status was established during the rapid development of global institutions such as the United Nations, Bank of International Settlements, World Bank and others, the US Dollar assumed the role that John Maynard Keynes had campaigned for — a single, global currency through which to facilitate world trade. Where Keynes vision included a new currency called the Bancor (not to be confused with the crypto project), political realities at the time gave the United States the honour for good reason — by 1960 the GDP of the United States represented 40% of global output.

So the new financial system, first attempted in the Bretton Woods agreement of 1944 and then reorganised in crises during the Nixon shock in 1971 gave the currency — the USD — a complete and total domination of the global financial system in a way that is simply not comparable to any other currency that has been retrospectively labelled the ‘global reserve’.

This status and the reality of total synthesis between global markets and the USD was not just planned and organised as a good faith project to smooth frictions in global trade (which it was) but was also actively pursued by US Foreign Policy, including pricing commodities in USD. This has been most notable in black gold (but also gold gold). Pricing oil in USD also came as an economic necessity after OPEC’s oil supply shocks of the 70’s threatened economic activity and the US pursued their dangerous relationship with Saudi Arabia.

So although the reserve status had encouraged the label of it being an ‘exorbitant privilege’ by Giscard d’Estaing the French Minister of Finance in the 1960’s, the trading status peaked in the 1980’s and 1990’s after the deal in oil was made and with a total stranglehold on global trade the US Dollar index all-time high was on March 5, 1985.

That it peaked so long after US domination of the global economy speaks to the power of settling transactions in US Dollars.

During this same time period, where the US had peaked in economic power the Soviet Union emerged as an existential threat with ideas such as mutually assured destruction in nuclear war.

And it was after this threat had lifted when the Berlin wall fell in November 1991 that things had started to get a little bit weird culturally, socially and politically in the United States.

It was barely a year after the fall of the wall that in 1992 Francis Fukuyama published his book ‘The End of History and the Last Man’, a task we often refer to that gives a complete view of the cultural, social and political perceptions of the time. The relief of the fall of the Soviet Union and the end of it as an existential threat created an incredible hubris in an economic power that had already begun to weaken relative to other nations.

So when Alan Greenspan took on the role as Chair of the Federal Reserve, tinkering with the financial system in unprecedented ways it hadn’t and couldn’t occur to those in power at the time that they were endangering the validity of the system they relied on, a gradually fading superpower acting with the hubris of the end of history and radically experimenting with the worlds financial system.

Due to this confluence of events, where the absolute high-point of the currency was in 1985 and the end of existential threat (and risk itself) in 1991 it was not even a decade later before the United States could not help but abuse its exorbitant privilege.

The first warning sign of trouble came during the ‘Tequila Crises’ in 1994, when the US Government rallied upto $50 billion dollars towards Mexico and the Peso to recover $26 billion of bonds that had gone bad. Between Bill Clinton, (who later campaigned for the disastrous entry of China into the World Trade Organisation), Alan Greenspan (who corrupted the global financial system) and Larry Summers, (the academic economist who, according to Nobel prize winner Joseph Stiglitz) who asked the final piece of the puzzle, Clintons Secretary Robert Rubin (ex Goldman Sachs co-chairman) ‘what would Goldman think of that?’, repeating the question at another meeting later.

When they short-circuited capitalism in this way, acting as a backstop to risk (for friends) they corrupted the essence of the system they were custodians of. Accepting and embracing risk is essential for a functioning system, but in the ‘End of History’ there would (apparently) never be risk again.

The Frog in the Boiling Water

This event was the first discernible corruption of the US Dollar and global financial system and the essence of this event ran through the Long Term Capital Management bailout where the usual suspects, the sharks of institutional finance used public money to acquire cheap assets in what was touted as an international emergency (it wasn’t).

Shortly after, the US Dollar index hit its highest level (since 1985) in the year 2000 and Gold bottomed out in 2001. After the September 11 2001 attacks the US military added $500 billion per year to its budget and spent something like $2.4 trillion on the Iraq war itself. Gold had almost doubled by 2003 and the dollar index had come off over the same time period.

Upping the ante after the 2000 bubble, Greenspan gave away cheap USD until there was a housing bubble and the arrogant financial sectors’ smartest guys in the room created highly complex financial instruments in enormous notional amounts to threaten the global financial system during the Global Financial Crises.

So despite the thread of corrupted decision winding itself throughout the cultural, social and political substrate heavily since 1991, major threat to the US Dollar emerged during the Global Financial Crises.

The GFC broke new ground, and when $500 billion dollars were used to bailout banks the world was shocked but the US Federal Reserve went on to expand the monetary supply by a total of something like $3.6 trillion USD.

With similar strategies adopted around the world the ‘exorbitant privilege’ of the USD became a structural fault-line in the global financial system, where the weight of the US economy was threatened by its inflated purchasing power. A ‘danse macabre’ began with the Chinese manufacturing sector, systematically undermining the basis of the relationship by hammering US manufacturing and its purchasing power while simultaneously building an enormous economy dependent on the purchasing power it was eroding.

So by the time that the Coronavirus impacted the global economy the structural significance of the US Dollar to the global financial system had pushed the set of relationships between assets, prices, markets, trade, nations and currencies to very warped and disjointed places. The financial system was not coherent with the global economy and a feedback loop had been created where a bloated financial system required artificial injections of capital to merely maintain itself – $500 billion to repo markets in late 2019.

Of all warped relationships and structural extremes, one of the most notable examples has been the historical silver to gold ratio being pushed to 126 : 1 this week. This ratio was stable throughout most of history until the advent of central banks, bank notes and modern financial innovation threw it out of its traditional relationship in the 20th century.

So What’s the Remedy?

So when we keep in mind that we have never seen a network of international trading relations as we do today, with the US dollar stretching throughout all of global trade, with that power used to enforce political sanctions, with military action firming up the petrodollar, with rampant abuse of the power of printing money and a delusional arrogance in the US Elite (perhaps best summed by Karl Rove’s derision of the ‘reality based community’) we are seeing a reduction of the authority, relevance and power of the US Dollar.

The end result is that a significant danger and opportunity emerges in what is accepted as money, especially for the digital assets space. The enormous, warped and enduring set of relationships dependent on the US Dollar must unwind, potentially very rapidly, as the weight of the US empire, its foreign policy and monetary and fiscal policy begins to release the tension holding assets, prices, markets, currencies and economies in their strange places.

And when we view the historical set of ‘global reserve currencies’ we cannot make any comparison with any other handover of this status. Although it is imprinted on the currency that ‘In God we Trust’, the lack of trust in the US dollar is already past the point of no return.

We take this to be the reasons why Bitcoin and Gold have had a great run. Central bank buying of Gold is at multi-decade highs, Bitcoin has recovered over 75% of its value from its low and the game has just begun in developing new ideas about money and the roles played by various commodities moving forward.

There has never been a better time to be involved in digital assets.

Written By: Thomas Kuhn, CFA

Thomas is a 12-year veteran of financial markets working to bring digital assets into the fold of traditional financial markets.  With an interest in fundamental analysis with a technical overlay, Thomas actively takes positions in the markets he covers. As well as producing education for traders, Thomas writes for Mine Digital, CFA Asia-Pacific Research Exchange and Hackernoon.

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