What if the US lost its world reserve currency status? What might it look like?
I suppose the first question is; what does it mean that we have the “world’s reserve currency”? At the end of WWII the allies met at Bretton Woods and decided to use the US dollar as the official world currency and that it would be backed by gold. All worldwide trade would be priced in dollars and settled in dollars. Food, energy (oil), etc from around the world would be priced and paid for in USD. New York became the financial center for all world trade.
Fast-forward to President Nixon in 1971 and the USD was cut loose from the gold standard due to OPEC oil imports and a growing imbalance of trade that was causing gold to flow out of the US in large amounts.
Today goods from around the world flow to the US and newly created paper dollars flow out. (Well not really paper dollars, just newly created electronic digits made up on a computer.) In essence we create IOUs that everyone must accept due to the Bretton Woods agreement and they send us their stuff. Once we completely figured this out we decided in the 1990’s that we would “think” and they would “work”. The US was going to run as a clean “information society” and all that dirty industry would go somewhere else. Our balance of trade kept getting worse and worse. We imported way more than we exported. We used to report our imbalance of trade numbers a couple of decades ago with great concern. Now no one seems to care at all since it is so far out of balance that it can never be fixed. (Sort of like an annoying knock in the engine that you fix by turning up the radio.) Ocean going freight containers started to pile up over here because we didn’t have enough goods to send them back fully loaded. For a while we sent hay overseas in freight containers because we had to send empties back to get them refilled so they greatly discounted the freight on the backhaul or return trip. Many people have started to find creative uses for these freight containers that are building up over here. They are the empty boxes on Christmas morning. Who sends the empty boxes back to the store for more toys? You just get new boxes.
Under the original Bretton Woods agreement if one country imported more goods than they exported the difference was settled up in gold. After a while the lazy country sent so much gold overseas that its currency dropped in value and they could not import as many goods. The lower priced currency made their exported goods more competitive so they began exporting more and the gold flowed back. When the link to gold was cut this self-regulating mechanism was broken. So now why should the US export anything? Why not import everything and just pay for it all with USD made up from nothing? Works great for the US but everyone else may have a problem with that system.
So why does the rest of the world still accept our USD electronic digits? One reason is the rest of the world can still spend them at the Middle East gasoline station to tank up with oil. In the late 1970’s and early 1980’s a deal was cut with the Saudis that so long as they priced their oil in USD and USD only, we would support their family rule with the full force of the US military. So even though we did not export enough goods to soak up all of our exported USD, the Middle East did. The OPEC countries then purchased our US bonds with their excess USD and earned a pretty good interest on their USDs – until now. Whenever someone in North Africa or the Middle East failed to live up to the agreement they were “replaced” with someone who would.
The whole system is now broken but still working somewhat. The only reason the rest of the world has not thrown it out altogether is there is not anything else to easily take its place. (Your thoroughbred now is old and swaybacked and stumbles along but it is still better than walking.) The world thought the Euro might offer an alternative to the USD when it was first launched. We all see where that is now leading. Doug Casey famously said, “The dollar is an IOU nothing but the euro is a who owes you nothing.” It seems that the euro is not going to offer the USD any serious competition. The USD is still the prettiest horse at the glue factory.
So what is next? Well the BRICS (Brazil, Russia, India, China and South Africa) have started their own development bank. This cuts the World Bank out of the picture in much of the world. The G-20 is talking about alternative currencies to challenge the USD and perhaps replace it one day with something a bit more fair to everyone else. China is cutting trade deals directly with Brazil and Australia outside of USDs. India is cutting deals with Iran outside of USDs. This is in direct violation of the Bretton Woods agreement. However, these countries feel they are exchanging value for value in their trade with each other on a more fair and equitable arrangement.
What would make a new reserve currency attractive? If the country that issued it had a trade surplus or at least balanced trade with the rest of the world a lot of the resentment would disappear. If the new currency were backed by gold once again the self-regulating mechanism would be fixed causing no one country to benefit to the detriment of another. If a basket of currencies were used from several strong countries with both of these attributes then even better.
Rumor has it that Russia and China have both been working hard to build up their gold reserves and they are both about 5 times the US gold reserve at its peak. Rumor also has it that the US gold reserve is maybe not as large as reported.
What if instead of Greece (or another PIIGS country) pulling out of the European monetary union and reissuing its own currency that something more interesting happened? What if the strong man with the 3rd largest gold reserves and a strong export economy pulled out and reissued its own currency – backed by gold! What if Germany pulled out leaving the Euro to collapse? Then what if Germany looked east and linked up with Russian and Chinese currencies that were also backed by gold? A new reserve currency made up of a basket of these three currencies (all backed by gold) would be a Eurasian powerhouse.
But where would this leave the USD? So long as the Middle East Gasoline Station was still in business and accepting USD it would survive. But what if the Muslim Brotherhood took over Saudi Arabia? What if the house of Saud fell? What if the Chinese would not loan us any more money to mount Gulf War III to save the house of Saud? There are several “ifs” here but what might happen?
If the rest of the world could not spend their USD reserves at the Middle East Gas Station and we are not able to ramp up our exports and sell them something they might want, then what exactly would they do with those USD? Why would anyone else in the world want them? And since 1971 we have been sending them all over the world and they have been piling up in every corner, there are a lot of them out there that suddenly find themselves unloved.
I believe that all at once there would be a race to spend them all at the only place where they must be accepted – to the only place where they are legal tender for all debts both public and private – right here within the US. They would buy everything that was not nailed down. Cranes, bulldozers, tractors, trucks, ships and entire factories all to be crated up and carted off. The mad rush of so many dollars would cause these items to be bid up to very high prices in USD. This of course would devalue the USD even further. All of a sudden all those old ocean containers that have been piling up over here would be filled to capacity hauling assets off as fast as possible. All of those IOUs would come home to roost at the same time. Of course we could default or slap on export taxes of 1,000% or some sort of currency controls for repatriated USD. They could even call all of those USD overseas illicit drug money and seize all of it! But that might lead to a war or several wars. Wars have been fought over issues far less trifling than that. No one likes to get stiffed on an IOU. Especially the largest pile of IOUs in the history of the world.
Assuming that we did the right thing and honored our debts. What would the US look like after the smoke cleared? What few factories remained would be largely owned by foreign interests. With much of the means of production carted off we would have a hard time exporting more than we consumed. Anything imported would be terribly expensive priced in USD. A trip to Wal-Mart would be like going to Neiman Marcus. Since we no longer grow enough food to feed ourselves our imported food would be very expensive. If the welfare state continued the dollar would devalue even more and finally collapse. Everyone would have to accept a much lower standard of living as we worked in factories owned by foreigners. As our dollar finally devalued to a fraction of its former glory the US would become a cheap labor country. Factories would move back to the US for the same reason many moved to Mexico in the 1980’s and 1990’s. Slowly we would rebuild and in a few generations we could be a first world country again.
So what can you do now? Where can you run? When the War Between the States began and the first Battle of Bull Run was fought, Southern General P.T.G. Beauregard set up his headquarters in the home of Mr. Wilmer McLean. Mr. McLean was too old to fight in the Southern army and sought to move his family to safety. He glanced at the map and picked a nice safe place 120 miles further south – in Appomattox. You see the war started in his front yard and ended in his parlor as General Lee surrendered the Army of Virginia to General Grant several years later. The first and last great battles of that war both found Mr. McLean. Sometimes you can run from danger but in the wrong direction.
Take some time and carefully think things through for yourself. Make sure you are not jumping out of the fire and into the frying pan. A storm could be coming our way. Build a good storm shelter just in case. Years too early are better than seconds too late.