Friday, October 9, 2009

The Coming Demise of the Dollar

I’ve mentioned this in Open Threads and discussed it in comments on other blogs, but I held off reporting it here until I found an article that explains the impact well.

dollar-plunges The big news this week on the financial front was the Independent’s claim that Gulf Arabs and France, Japan, Russia and Japan were planning to move from buying oil in dollars to buying it in a basket of currencies, including gold and a new universal currency shared by the Gulf nations.

Buying oil in dollars is one of the foundations of the dollar’s role as the world’s primary reserve currency. Because the the dollar is the world’s primary reserve currency Americans have been able to borrow money for significantly less than other countries are able to. This has both made America more prosperous, and through the perverse incentives of cheap money, helped lead to the high indebtedness of American citizens and the financial crisis.

In addition, buying oil in dollars is one of the things which allowed strong dollar policies to drive the price of oil down. Making dollars extremely scarce in the 80’s and nineties was one key factor leading to a price per barrel under $20. Oil prices started their rise upwards after Greenspan’s Federal Reserve let loose the money spigot in the Asian crisis and the Long Term Capital fiasco. Greenspan essentially never took his foot off the pedal from that point onwards, and oil prices soared, until last year at one point they were over $150/barrel.

So one consequence of going off the dollar is that a major benefit of the strong dollar play is taken off the table, and the US loses its ability to control the price of oil. Since at this time, contrary to what the Feds are saying, a strong dollar play isn’t in the cards (the US needs to borrow way too much money) that’s not a big deal in the short run—in the long run it is.

But buying oil in dollars isn’t the only thing that underpins the dollar as the world’s reserve currency and to understand what buying oil in something other than dollars would mean we need to understand what else makes, or perhaps more accurately, made, the dollar so important.

Technological Revolutions: Remember the internet boom of the nineties? Remember the way that money flooded in from the rest of the world to buy up internet stocks? Sure, most of them turned out to be worthless, but some didn’t. When the US was the nation most likely to create the next technological revolution you needed dollars so that when it occurred you could buy in on the ground floor. Whether microcomputers in the 80’s or the internet in the 90’s, odds were that America was going to create the next big tech. So foreigners needed to be in the dollar.

At this point the US is the undisputed leader in almost nothing except military tech. As expected, US dominance of the arms sales market continues to increase, but the US can’t live on weapon sales alone. In most other fields, including telecom, the internet, large chunks of biotech, renewable energy, ground transportation and so on the US now lags other modern economies.

The structure of the US economy, with a few large oligopolistic firms dominating the market in key fields needn’t necessarily mean no technological advances, after all Japan and Korea certainly have high concentrations of large firms, but US firms such as the telecom giants essentially don’t engage in research, don’t believe in upgrading infrastructure more than they have to and are rent seeking corporations—they provide an inferior product to a captive audience (as with insurance companies) knowing that Americans have no other options. If they fail, they expect the US government to bail them out with huge subsidies.

This structure means that the US, is unlikely to be the home of the next great technological revolution. The next tech reveolution could happen in the US, with the right policies, but the Obama administration has not engaged in those policies, instead spending trillions on propping up failed business models.

Consumers of Last and Main Resort: For decades now Americans have bought a ton of consumer goods, from cars to electronics to clothes. As time went by, more and more of these goods were bought from foreign countries, and more and more of it was bought on credit. America and Americans have been the engine of development for Japan, the Asian Tigers, and most recently, China. China, Japan and Korea, in particular, used mercantalist policies—that is to say they generally used trade barriers to protect their internal economy and subsidies to help their exports. China’s main trade barrier and subsidy is its massive interventions to keep the Yuan cheap against the dollar, an intervention which has amounted to as much as 10% of China’s GDP.

That intervention has left China with a huge number of dollars denominated assets. In effect the Chinese loaned America the money to consume Chinese goods, which simultaneously made American manufactured goods uncompetitive which meant that manufacturing employment in American dropped like a rock while new factories opened in China rather than the US. In exchange for the money they loaned America, China industrialized. Even if they don’t get most of the money back (and they won’t) it was a good deal for them. As for Americans, well, Americans were able to live above their means—those who didn’t lose their jobs, anyway.

Many countries export a lot to the US. While US consumers have pulled back significantly, they still consume a lot. There is, as yet, no replacement for the US consumer. China and other countries may wish there was, but there isn’t.

The American Security Product: One of the main reasons other countries were willing to, in effect subsidize the US, for decades, is that it provided the common security product—against the Soviets, then against real rogue nations, and always against pirates.

In particular, America’s navy is as large as the next 13 navies combined. The US was responsible for keeping the world’s shipping lines open, and it was the core of the NATO hammer when a problem needed to be dealt with (for example, Serbia in the late nineties.)

But lately the US hasn’t been delivering the product in a way that the rest of the world appreciates. Most of “old” Europe (ie. the countries with money and power) opposed it. So did most of Asia. So did America’s allies in the Middle East. Once in Iraq, the US couldn’t be defunded for fear of Iraq splintering, but now that it’s clear the US is leaving anyway, the possibility exists.

And then there’s the Somali pirates. Because most of the US navy was occupied with the wars in Afghanistan, Pakistan and Iraq, the Somali pirates got completely out of hand and the US Navy didn’t do anything about it for a long long time. When the issue was finally dealt with, the US navy was only one of a number of navies doing so. The US let it get out of control, and then wasn’t key to fighting it.

Now that the US no longer protects very well against the Soviets, rogue nations or pirates, and now that joint naval operations are how the Somali pirates are being dealt with, the rest of the world is wondering whether it’s worth paying for a US military which doesn’t do what they want it to do. Only the Afghan war, which has elite support in Europe (though not popular) makes some think that perhaps the US is worth keeping on as the world’s policeman.

Buying Key Technologies Required Dollars: Yet another reason folks wanted to have lots of dollars and access to dollars was that you needed dollars to buy certain goods. For decades the only good commercial jet liners were Americans. Key computer technologies needed to be bought in dollars. Intellectual property needed to be bought in dollars. The best military technology had to be (and still has to be) bought in dollars. And so on. The US wasn’t just home to the next technological revolution, it was home to all the good things you wanted to buy and which you couldn’t buy in your currency.

This is, with a few exceptions, no longer true. The Europeans and Japanese can sell you most high end capital goods. There is no real difference between Airbus and Boeing products (though both are essentially 30 year old technology). The Chinese can and will sell you middle and low end goods for less than America. You don’t need dollars to buy most of what you need and want, and if something comes up really worth buying (say General Motors) well, if you’re someone who really wants it, like the Chinese, you just won’t be allowed to buy it anyway. (The Chinese would have loved to buy GM.)

A Safe Haven For Money and For You: For decades, if you wanted a safe place to put your money and put it to work, the US was probably the best. It was the most stable, it was impossible it could be conquered even if there was a World War III, it was the largest and could absorb the most money. Likewise, if things went really bad in your country, it was a great place to flee to.

The financial crisis put the wisdom of placing your money in the US in question. Bush era immigration and travel policies, not rescinded by the Obama administration, put the utility of the US as a safe haven in question as well. And yet, to an extent, the US retains at least the first role, because there is simply no other country available. Europe did not avoid the financial crisis, China doesn’t allow that much investment in the country and is an unsafe place to put money, and so on. So the US retains some safe haven appeal. At the same time, however, foreign elites have become far more uneasy about the idea and want a different option. And for themselves, they’d rather vacation, have their second homes and educate their children in Europe.

And at last, back to oil: Of course, the final and in some ways most important reason for the dollar’s reserve currency status is that oil was sold in dollars. This is a result of a decades long understanding between the key Gulf States, Saudi Arabia and America that the US both underwrote their security and could knock them over any time it wanted. In exchange for America’s security umbrella and help in maintaining their regimes, oil was priced in dollars. When they became rich in the 70s, their money flooded primarily through US banks.

Indeed, in prior years, every time an OPEC nation talked about going off the dollar as the currency for buying oil, rumor has it that the Saudis were the ones to spike the move.

Oil is the most important commodity in the world. Ultimately all economies are underpinned by oil. Oil is also the most important military resource. With oil your army can move and fight. Without it, it can’t. In many ways WWII was fought for oil and with oil, and the powers with the oil defeated those which didn’t have it.

Which brings us back to the US military product. As long as oil is priced in dollars, the US military can always function at full capacity, because if push comes to shove, the US can always just print more dollars.

If oil is not priced in dollars, then certain US access to oil is removed—both for the military and for the civilian population. Sure, the US can still print more dollars, but if oil isn’t priced in dollars, well, print too much and you may get inflation, even hyperinflation. And if the oilarchies don’t approve of a particular military action, well, they can make it much more expensive.


Are the Dollar’s Days as Reserve Currency Over?

No. They aren’t. But they are numbered. They aren’t over because other nations still need the US consumer. Until the Chinese manage to create a domestic consumer society, both they and other countries can’t cut themselves lose from the US consumer. What they will do, and what they are doing, is trying to manage how much the US borrows and to take away the US ability control the world’s money supply. They will still have to keep the US propped up for the time being, because in so doing they are propping up themselves. And remember always that Chinese citizens aren’t like Americans. Take their jobs or their land or their hope and they get violent—very violent. They have, do and will fight both the police and the military. China’s elites know that if they don’t keep economic growth coming, their heads could literally wind up rolling.

In addition, while no one is happy with the US security product, the fact is that no one can really replace it. The European military is not strong enough, and their navy does not have the projection ability. Likewise with the Chinese military, who in any aren’t trusted half as much as the Europeans, though their moral flexibility is appreciated by many regimes, who still understand you don’t invite China to station large number of troops in your country if you have half a brain.

Likewise, there is simply no replacement for the US as a haven of last resort. China’s currency and investment controls make it unsuitable. Europe managed its financial affairs no better than the US over the last decade, although they seem to have learned the regulatory lessons marginally better than the US. If you need a place to store your money, and put it to work, the US may not look good, but neither does anyone else who is large enough to absorb large amounts of money.

The key break point, the end of the dollar hegemony, will come when the Chinese are able to move to a consumer economy. At that point, the Chinese will no longer need America as consumers, and they will let the Yuan float. The devastation this will wreck on the US economy is hard to overstate. Standards of living will crash. In the long run, being forced to live within its means, and no longer having to compete against massively subsidized foreign goods may turn out to be good for the US, but that won’t make you feel better as your effective income collapses or you lose your job.

This is probably two economic cycles out. We’re talking 12 to 16 years. So there’s time yet. Probably… [emphasis original][emphasis added]

Inserted from <Crooks and Liars>

Tom122007 There you have it.  Mene mene tekel upharsin.  We have twelve to sixteen years to fend off economic collapse, and if we fail to do so, the consequences are bleaker than I care to imagine.  So what can we do not to minimize the effects?  First, we need to recognize what got us here.  Since the Republican Revolution brought in with Reagan, GOP economics rewarded greedy corporations for making money instead of making things.  We moved from a manufacturing economy, to a technology economy, to a service economy, and finally to a consumption economy.  When the US consumer is bled dry, and the economy has collapsed, Wall Street will just move offshore, gorged with decades of ill-gotten gains.  And the GOP will scream that the Democrats were responsible.  Much of the damage is already done.  But there are still some steps we can take.

  1. Break up the companies we bailed out.  Too big to fail is too big to exist.  The last thing we can afford is to keep financing their corporate greed at taxpayer expense.
  2. Pour resources into education.  Without the brain power to innovate, we have no chance to reclaim our role as a leader in technological innovation.  We can provide an education to anyone capable of mastering the work, from kindergarten through post doctoral studies, paying for their tuition, books, room and board.  In return, they can provide national service, at a reasonable wage, for a period of time after their studies are complete, with the length of service dependent on the level of education completed.
  3. Pour resources into research and development.  Provide tax incentives for companies who invest in new technologies, and penalize companies, like the giant telecoms who do not, preferring to deliver inferior services to captive customers.
  4. Pour resources into green energy.  If we can no longer control the price of oil, weaning our society from foreign oil becomes an imperative.
  5. Pour resources into infrastructure.  We cannot support a thriving economy on our decaying highways, bridges, utilities, etc.
  6. End tax breaks for companies who manufacture overseas.  If a corporation, manufactures in China, and writes off manufacturing costs as an expense here, then all the profit they make from the sale of those manufactured goods should be taxed here, even if they sell them somewhere else.
  7. Finance these programs by taxing the rich.  The top quintile (20%) in the US own 84.5% of the wealth.  The bottom two quintiles (40%) own o.2% of the wealth.  The rich achieved this gross inequity by getting us into this mess.  Let them pay to get us out.

The Republicans will surely scream that all this spending will bankrupt our grandchildren.  Let them scream, but remember that if their policies continue, those grandchildren will be born in a third world country.

Other than the seven points I brought up, what else do we need to do to prevent the collapse of our nation?




Your to-do-list to get the US out of this financial mayhem is brilliant.

If the Republicans still refuse to see the imminent danger of an endruing economic collapse for the next generation, perhaps, it's time to disand the party too? (heh!)

Seriously, I am probably not as concerned as you are but I feel concerned too -- I wouldn't want to witness the "collapse" of America into a third world.

The "demise" of American technological and financial domination will reverberate across the western world and will a nefarious effect on the western world's way of life. Selfish that I am, I don't want that to happen.

These actions in your list are doable NOW:

"Break up the companies we bailed out." is one of those things that the state can do if the state owns them. It's been done before (France did it.) Or force those companies to merge.

"Pour resources into research and development. Provide tax incentives for companies who invest in new technologies, and penalize companies, like the giant telecoms who do not, preferring to deliver inferior services to captive customers."

The western world is being overtaken in the area of new technologies by the emerging Asian "tigers", China included. If we don't incite technology companies to keep up speed, there are chances that we will be overtaken. Tax incentives will definitely help.

"End tax breaks for companies who manufacture overseas. If a corporation, manufactures in China, and writes off manufacturing costs as an expense here, then all the profit they make from the sale of those manufactured goods should be taxed here, even if they sell them somewhere else."

Instead, tax breaks should be given to those companies that stay in America or provide for tax holidays. America must go back into manufacturing and must go back into consumer mode of consuming what they produce. Even if that means for the labour force getting pay cuts, perhaps, it's better than not working at all.

"Finance these programs by taxing the rich. The top quintile (20%) in the US own 84.5% of the wealth. The bottom two quintiles (40%) own o.2% of the wealth. The rich achieved this gross inequity by getting us into this mess. Let them pay to get us out"

Increase tax for fat income earners. At a certain point, Ameria must di this. It is a bitter, very bitter pill to swallow. It might have repercussions, eg., flight of capital but that is where the State comes in. There must be worldwide taxation of large assets (we do that here.) It will be very unpopular but as you say, "The rich achieved this gross inequity by getting us into this mess."

Yesterday, David Cameron, in his keynote address to the Conservative Party conference confronted the taxation issue head on and said that there will be NO tax cuts -- will remain at 50% for big income. In France, we pay up to 65% for huge income earners. It's painful but we realise that unless we accept it, we will not be able to continue with our way of life.

At the risk of sounding a "moralist" which I'm not, I just feel that unless, America realises that a relative social-oriented doctrine is put in place, America runs the risk of falling into what we all dread "third world country" status.

Now, your problem is getting the Americans, from all sides of the political spectrum, to see through this judiciousness of having a social order, i.e., benefit of all.

Sue said...


great job Tom!!


Oh, btw, the author writes, "The European military is not strong enough, and their navy does not have the projection ability."

For more accuracy, there is no such thing as "European military". It's a fallacy to think that.

Each nation HAS its own defence or military force, much like the US. But we do have a struggling economic union called the European Union.

Each member nation is probabably a fraction the size of most American states and so even if you put the defence forces of all these nations together, they probably won't equal the strength in both numbers in war assets and troop forces of the US.

Naval projection ability of all these navies combined will not equal US ability either. For one thing, UK, one of the nuclear countries in the world depends much on the US for its naval nuclear arsenal (France is independent, thanks to Charles de Gaulle). So, if the author meant European "militaries", then I will accept that although we may not be impaired, we cannot compete with America.


After writing that, it just dawned on me that number per number, US has what, 44 states(?) while the EU has just half or a little more of that number(27 actually)!

Andrey said...

The next item on Obama's agenda should be to get government out of business and lower taxes. Businesses keep the country going, not politicians and activists. Without business and the incentive to make money, we'd still be using rotary phones and driving Model-Ts.

Randal Graves said...

I see you still want to stifle innovation, tom, by excessively taxing the poor, poor rich. The NFL has socialism and look where that's gotten the Browns! That's right, 0-4!

(how are you guys 4-0? When did you find a defense? And where?)

Border Explorer said...

I can see that you are more than simply an ordinary gentleman farmer. You are an academician gentleman farmer. Good stuff.

Mauigirl said...

Excellent post, TomCat, and I love your list of solutions. This is a bigger problem than many people realize, and I agree it is a likely scenario. And even if the dollar doesn't completely collapse, the country as a whole has been going downhill anyway and your solutions would address most of the problems we have right now.

TomCat said...

Wow, HB thanks! I really appreciate the kind words. {{blush}}. We have fifty states in the US, but a few are so red that the IQ levels there are too low to count them. ;-)

Thanks, Sue. First, I don't want the job. In my health, it would kill me. Second, ex-convicts aren't allowed to be President.

Welcome Andrey. I see you have a blank ID. Are you a professional spin-doctor?

Randal, the Browns are 0-4, because they are supply side capitalists. The Broncos are 4-0, because they are social democrats. ;-) Seriously, I have no idea how that defense gelled.

Welcome Billie. With that comment, I know where you came from. I'll have to give you an extra tree today. Thanks.

Thanks Maui. I think that these are the things Obama wants to do, but his circle of 'bipartisan' advisers stifles him. I hope we can get moving in short order.

MadMike said...

Obama needs to get over this bipartisan nonsense. I am not so sure that it is his advisers as much as it is him insisting that work can get done in a bipartisan manner. The Rethuglicans hate him. They will NEVER work with him, regardless of how good of an idea or how good of a bill it is.

Jolly Roger said...

The second post of Reconstitution, in November of 2004, was about the coming collapse of the dollar. I quite frankly don't know why it hasn't happened yet.

Since we don't back our currency with anything hard, our goods and services essentially stand in as the backing for the dollar. 30 years of Rushpubliscum "free" trade and subsidizing of offshoring were bound to do precisely what has been done. Your #5 is actually cause #1 and should be addressed immediately. The President talked of doing this, but the proposals are already being watered down.

rjs said...

there was probably something to the Independent story; the loud denials from the named participants in the secret meetings on the currency basket deal for oil are revealing; cant say that i blame them, though, their dollar holdings have gone down 12% since march...we'd panic too, and go looking for better medium of exchange if the green-inked paper in our pockets lost that much value in the world we live in, in so short a time...

btw, for those interested, i have links for about a dozen articles on the dollar on my weekly blog...

Mary Ellen said...

Great post, TC.

Break up the companies we bailed out. Too big to fail is too big to exist. The last thing we can afford is to keep financing their corporate greed at taxpayer expense.

Kinda tough to do this when our Congress and Senate votes to bail out companies, knowing that the majority of Americans don't want them to do it. It never fails, they make promises, we vote for them, they break their promises and walk away with a pocketful of cash from the lobbyists.

Pour resources into education. Without the brain power to innovate, we have no chance to reclaim our role as a leader in technological innovation. We can provide an education to anyone capable of mastering the work, from kindergarten through post doctoral studies, paying for their tuition, books, room and board. In return, they can provide national service, at a reasonable wage, for a period of time after their studies are complete, with the length of service dependent on the level of education completed.

It will never happen. That's too much of a socialist view and like it or not, this is a capitalist country. What "nationalist service" would you suggest they do? And how is that going to guarantee that they will get a job in the public market? Just because they participated in a vague "national service" does not guarantee a job or work. That's certainly true when you see the number of military veterans who are coming home to no jobs.

Pour resources into infrastructure. We cannot support a thriving economy on our decaying highways, bridges, utilities, etc.

I thought that is what the stimulus package was supposed to do. So far, nothing is being done. We will be paying for that stimulus package for years to come and I have the feeling that money will disappear before most of the projects are started.

It's not a matter of what we should do, TC, the problem is that we have people in power who gave us nothing but lip service and what we have to do first is get them out of office. But that won't happen because too many people don't care about who is in office as long as it's their guy...a "D" or an "R".

Our economy won't correct itself as long as our country is being run by corrupt policymakers and I don't see any trends showing that they won't stay in power.

Brother Tim said...

The attack on the dollar started in earnest about two years ago with the formation of the Iranian Oil Bourse. The writer says 12-16 years? He needs to take off his rose-colored glasses.

Try Googling 'Private Oil'.

Oso said...

very nice.The R's screaming about bankrupting our grandchildren surely know that all the education/green energy/infrastructure work is well worth paying for and will grow the economy enough to "shrink" the deficit as a % of GDP.

Andrey,govt is not IN business.In case you missed the last 10 years regulation and oversight have been steadily whittled down to nothing.We NEe

Oso said...

sorry,keyboard locked up.what I was saying,we need regulation of derivatives and capital requirements.There is no invisible hand in the market.

And Americans need to pay for things.We can't always depend on credit.The whole world can't be Blanche Dubois,somebody has to pay.
Lower taxes?we already have the lowest taxes in the Industrial world.At some point we need to pay the piper.

Brother Tim said...

"At some point we need to pay the piper."

Naw, the bankruptcy judge will dismiss his claim. ;)

Dave Dubya said...

It may already be too late, but Obama needs to quickly assume the role of FDR and become a "traitot to his class".

Time to rebuild our country with jobs to the workers and taxes for the rich.

rjs said...

ckmichaelson summed it up succinctly:

"Why is the dollar under attack and loosing value? Look at it this way: the issuer is broke and cannot pay its debts, which are guaranteed by its citizens, who cannot pay their debts. Next?"

TomCat said...

Mike, I fully agree. Bipartisanship with those who refuse to compromise can never work.

JR, you beat me on that one. I posted similar in the old here in 2006. Never before, however, has the handwriting been so clearly on the wall.

Great articles, RJS. Apologies for not having you on the blog roll here sooner.

Nunly, you're right. It won't happen right away, but that's what I said about getting the Republicans out of power in 2001. I'm here to inform, and information now plants the seeds for future success. You said, What "nationalist service" would you suggest they do? And how is that going to guarantee that they will get a job in the public market? Doctors and lawyers could practice their trade in free clinics. Scientists could do R&D in universities. Business graduates could advise startups in blighted neighborhoods. Prospective Nuns could fool around for a while before taking the vows. ;-) There would be no guarantees. There are none now, but under my plan, the students would enter the job market with experience as well as education. Of course, those who prefer to buy their education may opt out. I agree that we need to drain the swamp.

Brother, energy mercantilism is certainly a threat. I can't claim the expertise to predict how long it will take.

Oso, I don't think the tax rates (except those on the very rich) are as important as what we do with the revenues. Taxing the poor and middle classes to finance the rich has to stop.

Dave, I fully agree.

Brother Tim said...

Only God, Himself, could claim the expertise to give an accurate prediction. :) But judging from recent patterns, 12-16 yrs seems to be a pie-in-the-sky estimate if the bankers and corporations are not reigned in.

TomCat said...

Brother, even she might not know. ;-) Hope you're wrong.