Practical Dad

The Dollar’s Flaw as the Global Reserve Currency

Middle is now immersed in AP Economics, learning about variable and marginal cost curves and utility, yet still without any notion of something as basic as the definition of money.  This is a follow-up to a previous article that I wrote for him - So, Just What is Money? - because I find it problematic to learn about details without a general understanding of larger, more basic topics within the subject.  So, Middle, once again grab a soda and your earbuds and make yourself comfortable for another lesson.

There's a solid argument to be made, amidst the ongoing currency wars, that the American Dollar could soon lose it's status as the Global Reserve Currency despite its present big kid on the block status when compared with the rest of the world's currencies.  I frankly believe that it will happen and sooner than later.  Yet while there are many rationales and explanations for why this might occur, I think that the true reason rests at the economically molecular level of the definition of money.  Yes, many in the world want to see the dollar fall as a poke-in-the-eye to the arrogant Americans and God knows there are others who cannot reconcile a Global Reserve Currency with a huge debtload.  But the core reason is that we no longer manage our currency, the dollar, with the same emphasis as the remainder of the world must manage their own currencies and the world will somehow - messily - create a system that better aligns its needs.

Understand that there are three operative characteristics for anything that is agreed upon to serve as money.  First, it must be fungible such that any one unit of currency can be used in place of any other unit of that currency; in other words, a crisp new Benjamin from the bank can be as readily accepted as a Benjamin that you pull from your wallet.  Second, money is a medium of exchange which serves to simply make the daily transaction of business all that much easier.  My wallet is far less bulky with three Benjamins than it might be with the assortment of chickens and rabbits that might be required to purchase a like amount of goods were the Benjamins not available.  Finally, money should be reliably relied upon to serve as a store of value; it should be expected to purchase the same amount of goods and services in the future as it does today.  With a few exceptions in the world, most nations have a currency that serves as money because each sufficiently meets the three criteria that the population accepts it.  When there is a sufficiently large breakdown in a currency, such as in Zimbabwe, then the population creates and sustains a black market in some other material that serves in lieu of the local currency.

And it's here, within these three characteristics, that the flaw lies.  Since the end of the Second World War, the American economy has been predicated upon consumption as an economic driver and all efforts have gone to build and sustain that consumption.  The supposition is that as people spend their money on goods and services, that money flows throughout the economy and provides demand for other goods and services in a sort of virtuous economic circle.  It was during the Great Depression of the 1930s that the American government adopted Keynesian theory in the hopes of providing demand by running governmental deficits, using public debt as fuel for a stricken economy until it could recover enough to not require the debt-fuel.  That thinking has generally continued since then with debt run-ups shifting back and forth from private to public sector through the decades until there's presently a huge overhang of total debt.  The use of debt to fuel consumption also serves to pump money into the money supply, which is essentially an inflationary practice that not only has a domestic effect but an international effect as well since the dollar is the global reserve currency.  The upshot is that if business is transacted in dollars and the cost of a good rises as the supply of dollars rises, then any nation wishing to engage in business will see prices rise in its own currency since it would take more to purchase the dollars to satisfy the transaction.  The offsetting result to this practice is that while consumption continues and debt builds, such practices are inherently inflationary and slowly, willingly sacrifice the store of value characteristic.

This is apparently fine for our own country but it does create problems for the rest of the world.  The American economy since the Second World War has been something that's outstripped any previous economy in the history of the world.  Our citizens have prospered and reached a standard of living that no other society had ever before achieved.  Having a currency with the Global Reserve Status allows a privilege and latitude that people with other currencies don't enjoy if simply by dint that those with the GRC status can literally print as much as they choose while the Norwegians, South Africans, Jordanians and Chinese cannot.  These other countries must still contend with the quaint notion that money should serve as a store of value so that their people can continue the finer things in life, such as bread and adequate shelter.  They do not have the amount of wealth as the average American - or at least the .1% - and their economic security in the global economy is a bit more tenuous and dependent upon the policy decisions of foreigners than we are as Americans.  At least for now.

Writers such as Yves Smith of naked capitalism have explained how economists went to great lengths to quantify economics and make it into a hard-style science such as physics or chemistry.  Yet why a nation's currency is granted the GRC status is essentially unquantifiable, based upon non-economic factors.  It's that nation which is not only militarily strong, but also perceived to be solid and relatively prudent, at least until the leadership drinks the kool-aid and sends that nation down the path to Wonderland.  The key word is perception and that is simply unquantifiable.  But any money must meet the three criteria for common acceptance and there has to be a general agreement amongst all users - domestic and foreign - that there is a semblance of parity between the three.  There can be temporary discrepancies but if the semblance of balance isn't maintained, then pressures grow within the system until such time that the perception breaks and something new comes about to take its place.  In the case of the Dollar, the notion that a store of value could be maintained existed so long as the Dollar was essentially backed by gold, that material that everyone across the globe considers as the principal store of value par excellence.  But when Richard Nixon took the United States off of the gold standard in 1971, it was then that the notion of perception truly took center stage.  It is because we have chosen to so over-emphasize the medium of exchange characteristic, sacrificing the store of value as our leadership purposefully strives for inflation to simultaneously stoke consumption and inflate away our debt, that the rest of the world has altered their perception of our collective wisdom to manage the dollar in a way that is truly mindful of its status as the Global Reserve Currency.  There is no way to quantify how this perception has suffered or measure when such a massive change will occur.  But the rise of the BRICS and the increasing use of the Remimbi to settle international transactions makes clear that the Dollar's days are numbered.  The problem for the average person is that reading about it is, by nature, sterile and unexciting; real life however, is generally far more exciting and colorful as it plays out in the store aisles and down the street.  We have raised our children in a society that demands consumption.  We will have to collectively figure out how to raise them in a new society that is far more mindful of value than it has been in generations.

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