Thoughts on the Road to Damascus - US Dollar

JulieW · Oct 14, 2012

I've been pondering the concept of the AUD declining to around 80c against USD. I've also been having 'realisations' about the enormity of the global economy and the resolve of the Powers That Be to keep the game going 'at all costs'. These thoughts intersected at the following article concerning USD as global reserve currency and its potential to hyperinflation and a shambolic collapse of the USA and the developed Western economies.

I'd be interested to hear perspectives on the potential of the USD to remain the reserve currency for a lot longer, after all the USD and the GBP held a joint role of Reserve Currency for quite a few years, and the potential for the USD to naysay the critics (e.g Peter Schiff et al) seems strong.

The following are excerpts from a bullish perspective on the USD. It's worthwhile reading the whole link and considering the other issues raised.
http://charleshughsmith.blogspot.com/2012/10/what-will-benefit-from-global-recession.html

This is not to say that we don't believe expansion of base money is not dollar-negative; clearly, expanding money while the real economy of goods and services remains stagnant will gradually devalue the currency.

But there are other forces at work that complicate the simple case for a dollar decline based on Fed money-creation. For example, money is constantly being destroyed as paid-in capital vanishes in writedowns and write-offs. Many readers insist money is not being destroyed, but it has to work both ways: money can't just be created, it can also be destroyed.

To cite my previous example: if J.Q. Citizen bought a house in 2007 with $50,000 down payment in cash, and the house was sold in 2010 for less than its outstanding mortgage, that $50,000 is gone. It was real money, and it's gone. The fact that the purchase money went to the previous owner and mortgage-holder in 2007 does not mean the money is still floating around: a decline in asset valuations destroys money. Any loss booked by the bank is also real money, as the loss comes off the bank's cash reserve.

So if the Fed prints $1 trillion and $2 trillion in losses are booked in the same time period, base money has actually declined. In effect, the Fed is creating money to offset the deflationary effects of deleveraging.

There is another structural dynamic in play known as the Triffin dilemma or paradox. The basic idea is that when one nation's fiat currency is used as the world's reserve currency, the needs of the global trading community are different from the needs of domestic policy makers.
Prior to 1971, the dollar was backed by gold, which acted as a supra-national anchor to the dollar's reserve status. The gold standard inhibited both massive trade deficits and money creation, so it was jettisoned.
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Bancor and more:

A lively debate is taking place about how to "fix" the global currency so the U.S. doesn't have to run huge current-account deficits to provide liquidity and reserves for global trade. Some feel a return to the gold standard is the best solution, others favor a "basket of currencies" approach, while the International Monetary Fund (IMF) and other globalists unsurprisingly favor a supra-national new currency called the "bancor" overseen by (you guessed it) a global central bank.

In my view, the euro currency is a regional experiment in the "bancor" model, where a supra-national currency supposedly eliminates Triffin's paradox. It has failed, partly (in my view) because supra-national currencies don't resolve Triffin's dilemma, they simply obfuscate it with sovereign credit imbalances that eventually moot the currency's ability to function as intended.

What happens instead is the currency's central bank--in the case of the E.U., the European Central Bank (ECB)--attempts to square the circle by shifting surpluses from some nations (Germany) to those with structural imbalances via credit (debt). Correcting imbalances is the proper function of currencies, and the attempt to eliminate imbalances with a single currency has failed, for the simple reason you cannot eliminate imbalances between nation-states by brute force.

Now the ECB is attempting to paper over the imbalances with bank-issued credit.But the problem with credit is that it accrues interest, which must be paid in cash by somebody. Issuing credit does not resolve imbalances, it simply transfers the imbalance from the currency ledger to the credit/debt ledger. Eventually the imbalances destabilize the system. That is what Europe is experiencing but refusing to admit.

So where does the global recession leave the U.S. dollar? We know what happens in global recession: global trade declines as sales drop and "trade wars" arise to protect domestic economies from the ravages of global contraction.

The global demand for U.S. trade deficits to create dollar reserves will thus also decline. Domestically focused observers think that the Fed is the only creator of dollars, but in effect the U.S. creates dollars--and must create dollars--when it buys more from other nations (imports) than it exports. To expand their own credit base, trading nations need more reserve currency. This is the heart of Triffin's insight.

Another way of stating this is that the dollar will strengthen, buying more imports with fewer units of currency.

Those who believe the Fed's expansion of its balance sheet will weaken the dollar are forgetting that from the point of view of the outside world, the Fed's actions are not so much expanding the supply of dollars as offsetting the contraction caused by deleveraging.

Put another way, the global trading community and the domestic economy's interests align in a strengthening dollar. While many observers believe the Status Quo seeks a weaker dollar to boost exports, this overlooks the premium gained by the "exorbitant privileges" of the global reserve currency and petro-dollars. This premium is worth far more than marginal increases in exports.
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and the crux of the matter:

From the point of view of the currency markets ($2-$3 trillion traded daily) and global trading nations, the Fed's expansion of base money is marginal: after all, the U.S. has some $60 trillion in household assets, a $15 trillion economy, an expanding base of energy production, a dynamic private sector, a dominant military, the petro-dollar and the global reserve currency.

As destructive as the Fed's policies are to the domestic U.S. economy, from this point of view the Fed's actions are stabilizing actions on the margin. The real action is in the global expansion/contraction of dollars from trade and in reserves. It boils down to supply and demand: the demand for dollars as reserves will remain high, while the supply will actually decline as global trade contracts. The dollar will rise in value for this reason alone.

There is also the question of alternatives: what other currency could act as a reserve currency and trade in size without disrupting markets? The renminbi? It's not even convertible/liquid yet, and recall Triffin's primary point: countries like China and Japan that run trade surpluses cannot host reserve currencies, as that requires running large structural trade deficits.

The euro? Good luck with a bet on papering over currency/trade imbalances with credit designed to drain the stronger economies of cash. The Swiss franc? It's now a proxy for the euro and it's simply too small to trade in size. Ditto all the other small currencies. Japan? With its history of trade surpluses and its demographic/fiscal cliff looming?

Not only are there no real-world alternatives to the dollar, its strengthening will benefit everyone holding dollars everywhere in the world. That is a positive development.
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So with Australia a trading nation, how likely then that we'll continue at parity and above for the next few years at least?

Clawhammer · Oct 14, 2012

I think it was summed up recently by a Reserve Bank official (on ABC RADIO NATIONAL) whom was asked to comment on Aust. trade customers holding onto Aussie Dollars as a wealth preservation hedge. Said official remarked and I paraphrase;

' the point of having our floating currency (AUD) is so that other countries can buy Aussie products with it. The moment there aren't enough dollars to facilitate trade, they (the Reserve Bank) have no qualms about releasing more'

I think it pretty much sums up that there is a narrow band of currency valuation imbalances they will tolerate which they will address with currency outflow. What that band is though is anyone's guess.

mmm....shiney! · Oct 14, 2012

Whenever I see stuff about the AUD, I can't shake the image of Japanese society out of my head.

You know, stagnating economy, appreciating Yen, no sex, love of small dogs.

wrcmad · Oct 14, 2012

mmm....shiney! said:

Whenever I see stuff about the AUD, I can't shake the image of Japanese society out of my head.

You know, stagnating economy, appreciating Yen, no sex, love of small dogs.
Click to expand...

No sex? :lol: I'm guessing you haven't visited Roppongi!

mmm....shiney! · Oct 14, 2012

wrcmad said:

mmm....shiney! said:

Whenever I see stuff about the AUD, I can't shake the image of Japanese society out of my head.

You know, stagnating economy, appreciating Yen, no sex, love of small dogs.
Click to expand...

No sex? :lol: I'm guessing you haven't visited Roppongi!
Click to expand...

Not that sort.

And no, I haven't.

More the procreation let's make families type of sex. I guess it's the "I'll still love you even when the kids make you tired and they give me the shits, and you're old, grey, stooped, arrogant and obnoxious" type of sex I was referring to.

You know. That lifelong commitment type?

Or maybe you don't?

Yet.

:lol:

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Thoughts on the Road to Damascus - US Dollar

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