Monetary Basis of the Imperial Economy Part 4:
How it Might End
Things That Can’t Continue… Won’t
This is a slight reformulation of a quote attributed to Herbert Stein who was an economic advisor under Presidents Nixon and Ford. It seems a fundamental description of reality. If something is unsustainable, it will end. That does not mean that it cannot go on for a long time. It took Rome 150 years after the end was in sight to finally disintegrate. In a faster paced world, it is not likely to take that long.
People have long said, “don’t bet against America”. Well, they said the same thing about Britain, “the sun never sets on the British Empire”. There was probably some high ranking Roman official sipping an espresso in Downtown Rome in 180AD that said, “never bet against Rome”, not realizing that they were already past peak empire.
If you run into one of these types, ask them what happened to Rome, Byzantium, The Ottoman Empire, or any of the myriad of Chinese Dynasties? If they think that the U.S. will never lose its Reserve Currency status, then ask them who had that status before the U.S. The answer was Britain with the Pound Sterling. Then point out that, “oh, that status can change”. To really impress them you can point out the previous reserve currencies of the modern era: 1530-1640 the Spanish Dollar; 1640-1720 the Dutch Guilder; 1720-1815 the French Franc, 1815-1920 the British Pound Sterling, 1920-Present the U.S. Dollar.
Each of these political and economic powers used this status to enrich themselves as I outlined last week. Each one of them ran into the same problem the U.S. is experiencing; they became overstretched economically and militarily, and the internal contradictions of an inherently unstable economic regime caught up with them and imploded their system. There is nothing in the U.S. psyche that somehow makes the United States immune from this fate. Mr. Stein’s aphorism still stands as true. This cannot continue and so it won’t. I can’t predict the exact time, but I do think it is close. In any event, it is likely to happen in much the way the old saying about how a man went bankrupt, “slowly at first, then all at once”. Let’s outline some possible scenarios.
Reversing the Flow: Importing Inflation
If you believe in karma then this process will be a lot like a chickens coming home to roost moment. As I discussed last week reserve currency status allows the U.S. to export inflation and buy real goods and services with freshly created money that is being steadily debased. De-dollarization is the process where that made up money is sent back to the U.S. to buy up real goods, causing domestic prices to rise sharply.
The history of U.S. reserve currency status shows that the world’s demand for dollars acted as a “sponge”, or “sink” as I described it last week. This soaked up the excess currency (or liquidity) created by the Federal Reserve. This is what allows the U.S.to export inflation and have other countries pay for U.S. fiscal irresponsibility.
The first step is for foreign nations, like China, Japan and the BRICS (Brazil, Russia, India, China, South Africa, and several more) to accumulate trillions in dollar reserves. These reserves are typically in the form of U.S. Treasury bonds, that fund U.S. fiscal deficits. This had the effect of keeping those dollars from circulating in the U.S. economy and preventing an increase in U.S. prices.
If we see de-dollarization then all this reverses. If foreign central banks and their political masters decide that the dollar is no longer a stable store of value, either because of high U.S. debt and currency debasement, or because they tire of the U.S. weaponizing the U.S. dollar then they will begin to divest themselves of U.S. denominated assets. This is already occurring:
They will sell U.S. Treasury bonds and exchange their dollar holdings for other currencies, or real assets such as land, commodities or perhaps equity stakes in U.S. companies.
When a foreign entity sells dollars to buy something else, those dollars represent the made up, “unbacked” credit (debased currency) finally looking for a home. As these billions (or more) flood back into the U.S. they are chasing a finite amount of domestic goods and services.
The U.S. had previously enjoyed “seigniorage” (the profit from creating money that others hold). During the de-dollarization phase the U.S. loses this privilege. It now “must pay back” those real goods it imported all those years, albeit at much higher, inflated prices.
The Grinding Reality
As this de-dollarization continues interest rates will rise. To keep people interested in holding dollars (remember assets denominated in dollars, primarily U.S. Treasury bonds) the Federal Reserve will be forced to raise interest rates, likely sharply. Even if the Fed tries not to, the market will take long-term rates up anyway. The U.S. could engage in financial repression and force interest rates down, but that amounts to a socialization of the economy with all the negatives associated with it. In that case take all that I discuss below and accelerate it greatly.
The next thing that is likely to happen is that the U.S. will enter a bust phase. Higher rates reveal that many projects started during the era of artificially low rates are unsustainable. These projects were actually malinvestments. This is the core of the business cycle theory. This may be a tech bubble, or over-leveraged real estate.
Then, since the U.S. has offshored much of its manufacturing capacity over the previous decades because of this monetary policy, a now weakened dollar makes imports much more expensive. This is the most visible impact of this re-imported inflation.
In the original export of inflation, the U.S. government was the winner (the first recipient). In the re-importing phase, the U.S. consumer becomes the “last recipient.”
This de-dollarization is basically a global margin call. The world is returning all the I.O.U.s that the U.S. issued all at once and is demanding real assets in return. Needless to say, this will all be very ugly.
Gradual or Sudden
This could all go gradually or suddenly. I tend to think it will be gradual, but it is impossible to tell. If gradual then it will likely be a long-term bear market where inflation stays higher than its historical average, say 5-7% for a decade or more. In this scenario the world moves gradually to another reserve currency and the U.S. slowly loses its place of preeminence as well as suffering slower economic growth and must grapple with a reduced standard of living. A new reserve currency would then emerge.
If sudden, then it is likely a geopolitical event that triggers a mass sell-off of Treasuries, leading to a “crack-up boom” where the dollar’s purchasing power evaporates almost overnight. In economics a “crack-up boom” is the final, chaotic phase of a currency’s lifecycle. Coined by Ludwig von Mises, it describes the moment when the public loses all faith in the future purchasing power of their money and enters a “flight into real values” (holding anything but money).
For a reserve currency like the U.S. dollar, this is particularly feared because the collapse isn’t just domestic, it is a global liquidation of the world’s primary medium of exchange. I will not go deep into the wonky weeds about the “crack-up boom”. A good introductory article can be found here.
The important thing to understand is what happens if it gets to this stage. As explained earlier, the U.S. has exported its inflation for decades. In a Crack-up Boom, the world’s central banks and investors don’t just stop buying dollars, that would be bad enough, but they dump their existing trillions. Two really bad effects follow:
- Supply Overload: Trillions of “offshore” dollars flood back into the U.S. domestic market.
- Velocity Explosion: The “velocity of money” (how fast money changes hands) spikes. In economic theory, even if the Fed stopped printing, the sudden movement of these “returning” dollars would create a hyperinflationary environment.
Friedrich Hayek described central banks as having a “tiger by the tail.” To prevent a recession, they must print more money; but to prevent the Crack-up Boom, they must stop printing. For the issuer of the reserve currency, the “tiger” is the global economy. Stopping the presses would cause a global depression; continuing them leads to the final breakdown of the global monetary system.
This end-stage is to be greatly feared because money is the “nerve center” of a complex economy. When money fails:
- Economic Calculation Becomes Impossible: Businesses cannot plan for the future because they don’t know what the dollar will be worth in a week.
- Barter and Alternative Currencies: Society regresses to primitive trade or adopts a new medium (historically gold, or in modern discussions, potentially Bitcoin or a new commodity-backed basket).
The Crack-up Boom is the “margin call” on a century of credit expansion. It is the point where the market finally overrides the central bank, reasserting the value of real goods over paper I.O.U.s.
At this point it is more likely that the world will move to a new currency. Perhaps gold, maybe another national currency, or maybe Bitcoin. This is a more likely scenario than a return to barter and therefore barbarism. Nonetheless when the smoke clears the U.S. will see an economy in need of great repair with a likely much lower standard of living. Whether the U.S. political system can survive is another question. I doubt it. More likely is a slide into outright authoritarianism as desperate people fall for any silver-tongued demagogue promising them relief.
We Can Think Our Way Out of This
It is not too late to avoid either of these drastic scenarios. There is no way to avoid the U.S. losing reserve currency status, that is already baked into the system. Also, there is no way to change course without economic pain involved. Try curing a hangover without a headache to see what I mean.
However, if The U.S. begins to stand down now, it can successfully transition to a sound money regime and mitigate the damage and recover in reasonably short order. This means the U.S. can no longer live beyond its means. No more exportation of inflation and ripping people off by getting something from them for nothing. This means dismantling the empire and being prepared only to defend U.S. territory, sovereignty and transit in international waters. It means a drastic reduction of federal spending and a shift to only spending on those that truly need assistance.
None of this is easy, it may not even be politically possible. However, the choice is either do the hard thing now, and manage it more effectively and minimize the pain, or see a long slide into economic pain and political breakdown, or worse face the sudden breakdown scenario. I must admit that I am not confident that the U.S. will think its way out of any of this. More likely is a thoughtless slide into one of the two scenarios, bad or worse.
The awful specter than hangs over all of this is global war. If the U.S. does not manage through this smartly they may very well thrash about violently in the bloody death throes of a dying empire, not to mention how the world responds to a system-wide monetary breakdown. In a nuclear world we would be lucky to come out the other end. By we I mean humanity.
All we can do as followers of Jesus is speak the truth as we understand it, offer solutions grounded in reality and in the loving respect for the inherent dignity of all God’s children. Next week I will look at some possible ways we can personally survive the economic tsunami coming our way.
Praise Be to God
