The Almighty U.S. Dollar

 Unless you were born more than 80 years ago, you have never lived during a time when the United States dollar was not the undisputed dominant currency in the world. The Bretton Woods Agreement entered by the major economies in July 1944 formally acknowledged what was already generally accepted - the dollar would serve as the world's principal reserve currency. Furthermore, it would be the currency of choice for most countries to utilize when transacting international trade. 

Per the Bretton Woods Agreement, the dollar was convertible to gold at the fixed rate of $35 per ounce. The majority of countries in turn pegged their currency valuation to the U.S. dollar. This monetary system dissolved in 1971 when President Richard Nixon terminated the convertibility of the U.S. dollar to gold. From 1971 henceforth, the dollar and other major currencies have experienced a floating exchange rate. This is a system where the currency price of a nation is set by the foreign exchange market based on supply and demand relative to other currencies.

The dollar was and remains the obvious candidate to serve as the world's primary reserve currency. Similar to the end of the Second World War, the American capital markets continue to be deep, open to the world, and highly liquid. In addition, there is a track record of stability supported by investor protections and the rule of law. The U.S. represents practically 25% of the world's $115 trillion (annual) economy. Foreign governments and central banks around the world hold dollar-denominated assets, usually U.S. Treasury securities, as reserves to manage the foreign exchange value of their currencies or to weather economic shocks. Dollar assets comprise about 60% of global foreign currency reserves, down from 70% in 2000. The next highest reserve holdings would currently be the euro at 20% of the total.

Very few Americans truly grasp the benefits and significance of the dollar serving as the world's primary reserve currency. The dominant dollar has been called an "exorbitant privilege." And it is that, and more. A generous supply of dollars combined with strong global demand allows the U.S. to borrow money at a lower cost than if the dollar was not the world's principal reserve currency. A dollar at the top of the food chain reduces the cost of imports paid by American consumers. A strong dollar induces foreign direct investment in the United States. Long-term investment in businesses and property has been significant. The dollar's reserve status allows the U.S. to export inflation to a certain extent. While domestic consumers receive vast amounts of physical products of substance, in exchange foreign exporters receive vast levels of fiat money that has a history and future of debasement. The dollar has lost 98% of its purchasing power over the past century.

History tells us the U.S. dollar will ultimately be displaced as the world's dominant currency. Since the demise of the Roman Empire, there have been more than a dozen different currencies that sat at the top of the heap for varying tenures. The Dutch guilder succeeded Spain's silver dollar and dominated for the 17th and 18th centuries,. The United Kingdom's pound sterling was the primary reserve currency of much of the world in the 19th century and first half of the 20th century before being bumped off its throne by the U.S. dollar. There is no question that the dollar will eventually be replaced as the kingpin by either a different currency or an entirely new monetary system. The only question is when - will it be in two years, twenty years, or 200 years? I would lean toward the twenty-year scenario and I'll proceed to defend my thesis below.

Myself and many others predicted the imminent demise of the dollar in the past couple of years due to reckless, undisciplined fiscal policies and continued abuse of economic sanctions leveled on other nations by the U.S. It is time to eat some crow. I was wrong, and so were many others. We were caught-up in all the hub-bub surrounding proclamations that the BRICS' nations were about to unleash their own currency backed by a basket of commodities including gold. This may eventually transpire, but it probably is a ways off. I also failed to take into account higher interest rates in the U.S. and a robust stock market over the past two years. This induced foreign capital inflows which further supported the dollar. The fact of the matter is, currently there aren't any viable reserve-currency alternatives. The euro, Japanese yen, or Chinese renminbi are not in a position to replace the dollar. The dollar remains the cleanest shirt in a drawer full of dirty shirts.

However, over the next decade or two, unless something dramatically changes, I foresee the dollar gradually declining both in purchasing power and global importance. It may be the last man standing, but if powerful current trends continue on an unabated path, it too will tumble. Since leaving the gold standard over a half-century ago, the dollar has been kept aloft by the tax-generating ability of a growing, productive economy and a defense structure that has safeguarded the economy's strength. Cracks are beginning to widen in the foundation of the dollar. Central banks across the world have been de-dollarizing and aggressively increasing their gold reserves. Investors, both domestic and foreign, will continue to purchase U.S. Treasury debt as long as they believe they'll get their money back and that money has successfully navigated the storm of unrelenting debasement. Since I harbor little or no trust in our federal government, I suggest hedging in the form of hard assets and quality equities. If the United States moves to the point where the preferred policy is one of financial repression that allows  inflating the debt away, the market will consider and pursue alternatives to the dollar as a store of value.

The timing of a policy shift to financial repression is difficult, if not impossible, to predict. I expect it will be implemented over time in different phases. Along with financial repression, I foresee the Federal Reserve Bank pursuing and implementing a central bank digital currency (CBDC). There is no stopping the digital train. We are heading toward a cashless society. Most governmental parties claim CBDC will work as a supplement to fiat money with cash still allowed as an option in the payment system. I don't believe this for a minute. Central bank digital currencies will allow governments to exert more control over their citizens and facilitate complete oversight over all financial transactions.

Before I wander off on that tangent and go on a rant, I should tie a bow on this blog posting and speculate as to the probable successor to the U.S. dollar. At some point, there will be a global financial meltdown that will make the Great Financial Crisis (GFC) look like a Sunday school picnic. The major economies - United States, China, Europe, Japan - will gather somewhere and eventually agree on a new monetary system. The U.S. will no longer be a hegemon; the world will be multipolar; and globalization will be on the upswing again. At that point, I see the establishment of an international digital currency. Of course, I've been wrong before in the arena of making predictions.