What would happen to the U.S. economy if the dollar was no longer the world reserve currency?
We're frequently told that the United States has the greatest economy in the world.
Yet, there are many underlying facts many people don't know about. For instance, we're no longer producing the goods we need, while going through a de-globalization time.
We have huge trade deficits and our production doesn't equal our consumption.
In this article, I explain the reasons why the U.S. dollar is losing its reserve currency status and the consequences to this.
Production, Consumption, And The Trade Deficit
It's super important you get your mind around how this works so you can put all the pieces of the puzzle together.
I will explain it using this example: Let's pretend there's one country called 123 and the other one is the USA.
Cory is a regular citizen in the country 123, and he produces a lot of cotton, more than he consumes. That's key.
And Randall, who lives in the USA, produces 2 cattle a year. Every single year Randall and his family consume one cow.
So he has an additional cow he can sell to Cory who isn't very good at growing cattle. Cory gives him $100, and Randall, who isn't very good at growing cotton can take the $100 and give them back to Cory.
That way Randall gets the cotton that he needs. Both individuals, Randall and Cory, have the cotton and the beef they need for the entire year. It's a win-win.
They started the year with $500 each, and at the end of the year, they have the same $500 they had and the supplies they need.
But over time, Randall starts to get lazy.
He says, “Listen, I have been working my fingers to the bone, 12 hours a day growing the cattle. Life is too short. I only need one cow a year.
So I'm going to only work six months and I'm going to start going to the beaches of Bali for the other six months. I'll start vacationing, traveling, having an Instagram account, and really enjoying my life.
However, I still need the cotton. But I have $500 in savings. So every single year, I'll just deplete my savings a little by continuing to give Cory the $100, and then he'll still give me that cotton because he's still producing more than he consumes.”
After year one, Cory's got $600 dollars. Randall only has $400. Cory's getting richer, and Randall is getting poorer. At the end of five years, Cory has $1,000, but Randall is flat broke. He has $0 in the bank.
So, insolvent Uncle Sam comes along and says, “Randall, don't you worry! We're the richest country in the world.
You shouldn't have to work so hard. Plus, all these countries outside of the United States do business in dollars. So there's this artificial demand for dollars.
What we can do is sell Cory an IOU for $100 dollars, and all you have to do is vote for me next year. I'll give you that $100.
We'll just call it UBI, additional unemployment, or stimulus, something like that. But I'll give you the $100 so you can get the cotton you need, and you can still hang out on the beaches of Bali six months a year.”
Randall says, “Okay, well, that's fine for right now.” But for whatever reason, over time, Randall starts to get pissed.
He's looking at Cory, saying, “Darn it, that capitalist. I hate the fact that he's producing more than he consumes and he's getting richer while I'm getting poorer. It's just not fair. I need to fight this capitalist oppression.”
So Randall goes from being a cattle farmer to being Randall the rioter. He's out there on the street, protesting every day, looting businesses, starting fires, and just causing problems.
So the drunk insolvent Uncle Sam comes in and says, “Whoa, whoa, whoa, Randall. I know. I know life isn't fair. Let's do this.
I'll issue an IOU for another $100 to another country called XYZ, that just happens to be producing more cows than they consume.
So instead of giving you $100 a year, I'll give you $200 a year. Now you don't have to work at all.”
Now, let's think through what's happening. Randall is taking the money and giving it to country 123 that produces more than they consume.
They're giving the goods to Randall, but they're taking the exact same money and they're lending it to the U.S. Government so they can go and buy more votes.
What ends up happening over the longterm is country's 123 assets go up and up while the debt of the U.S. government goes through the roof.
This is how the United States trade deficit works.
This is the reason why people like Peter Schiff and Lyn Alden always say the United States is going into debt to consume.
The United States Over Consumption
Now let's take a deep dive into how the United States over consumes as a result of having the world reserve currency.
Then, I'm going to take what I've explained and connect all the dots so we can answer the question:
What would happen to the U.S. Economy if the dollar was no longer the reserve currency?
I already went over how the United States is able to consume more than it produces and how this creates a trade deficit.
And we can sustain that for a long time while interest rates are artificially low and the value of the dollar is artificially high.
In other words, if another country tried to do the same thing and run longterm trade deficits, their currency would have the tendency to go down in value and their interest rates would have the tendency to go up.
We can safely assume, that regardless of what the rates are in the United States and what they have been for the past 40 years, since we've been on an interest rate down cycle, that the rates are lower than they otherwise would have been if the United States didn't have the reserve currency.
Let's think through the knock-on effects…
- Stock prices have a lot more tailwind. So if they go up, people's 401ks, get bigger and bigger.
- This produces something I call NPPP, or non produced purchasing power.
Let me give you an example of what I'm referring to. An average Joe works a 9:00 to 5:00 gig, saves up $10,000 puts it into the stock market in some of the high flying stocks like Tesla, Netflix, or Amazon.
So his $10,000 grows to $100,000. Meanwhile, he hasn't worked an extra hour, hasn't produced any more goods or services, but now he has an additional $90,000 worth of purchasing power.
And let's remember the stock market has nothing to do with the economy.
Back in the old days, you could have argued yes. That the stock price went up because someone in the domestic economy produced more goods and services, but now that's completely removed.
The stock market almost has an inverse relationship with the real economy.
The worse the real economy does, the less it produces, the higher the stock market goes because of all the funny money the Fed has printed, and all the excess liquidity flowing into the stock market. It has nothing to do with fundamentals. It has everything to do with liquidity.
The bottom line is the stock market goes up artificially, and that produces additional purchasing power. And because we have these artificially low rates, we have cheaper loans, such as mortgages.
This means the home prices go up as well, just like the stock market did, consequently producing more NPPP.
This also produces lower costs of borrowing for all of businesses like Topgolf, Home Depot, and Target.
They can build more stores, get more inventory, hire more people, and create more jobs as a result of lower borrowing costs.
Which is a result of the dollar being the world reserve currency.
And this status translates to additional demand for the currency units outside of the US domestic economy.
This means the dollar is overvalued against other currencies.
So when we're bringing in all those imports that create the trade deficit we talked about, we're bringing in those goods a lot cheaper than we otherwise would.
When they hit the shelves of Home Depot and Target, which are two of the largest importers from China, all the people that have the jobs, that work at Home Depot, Target, Topgolf, and all the people that have additional purchasing power, non produced purchasing power, get the goods that they buy at all these big box stores a lot cheaper. This increases their ability to consume.
As a result of the United States has what a lot of economists have referred to as this exorbitant privilege, we have more Home Depots, more Targets, and we have something called Topgolf.
Which let's be honest, there's no way that thing, what exists if we didn't have the world reserve currency, that is for sure.
That thing would definitely be bust. But we also have a lot more consumption. We have people in the real economy like Amy and Mike that actually have jobs as a result, and they can afford to hire people like Stu, an Uber driver, to drive them around.
We also have Rich and Rich, who are getting more rich, even though they're not working any additional hours or producing any more goods or services.
And on the topic of NPPP, let's also remember Cory that's in country 123, and is accumulating dollars. We talked about him just buying treasuries, but he's also buying stocks and he's buying US real estate with all those additional dollars that he's accumulating.
This increases asset prices even further, which gives people like Rich and Rich, even more non produced purchasing power.
This also leads to social unrest because it increases the divide between the individuals who own assets and the individuals who are just typical workers in the economy.
I'm not saying that if the United States didn't have the world reserve currency, that it would be some third world country. But I am saying that San Diego would look a hell of a lot more like Tijuana.
Let's remember that when the United States gained this status, we had the most gold in the world. We earned that gold by producing more stuff than everybody else.
It's just, we've been riding on the coattails of what our grandparents did for the last 40 years. But sooner or later, this has to come to an end.
The Dollar Currency Endgame
I already explained in the previous sections how the United States is able to over-consume, under produce and how they've had a trade deficit for a long time.
And also, how this affects the everyday person like you and me. It drives rates down, it creates cheaper debt, and higher asset prices. The dollar value is artificially high.
This creates cheaper goods for the imports we're bringing in from other countries and it allows us to over-consume. Most likely for the last 40 years, since the early 1980s, when we've been in this down cycle of interest rates.
But to really connect the dots, to answer the question: What would happen to the US economy if the dollar was no longer the reserve currency, we have to really understand how it typically works between two countries when they trade back and forth.
Trading between countries
For this example, I'll use the old school USA, where we actually had a manufacturing base to our economy, and an imaginary country called XYZ.
If country XYZ is producing stuff more efficiently, they're going to export more things to the United States.
So we import their goods because we can get them cheaper. It's better for our consumers, and we're exporting fewer goods to them.
This situation creates less demand for the dollar.
So the dollar goes down in value against the XYZ country's currency. This over the long term gives the United States a competitive advantage because it makes their manufacturing goods cheaper for the consumers in XYZ to buy.
Therefore, in the next five, seven years, three years maybe, the US starts to export more things to the XYZ country. XYZ then exports fewer things and the dollar appreciates in value. There's more demand for dollars as a result.
The main takeaway is whichever country is exporting more this is going to have more tailwind to the value of their currency.
But, since the dollar has been the world reserve currency for so long, it's created structural issues in the United States.
Our economy doesn't look like it did before, when we had a significant manufacturing base and services.
Now, we barely produce anything, and the services are almost the entire economy, especially when you include government spending.
We can't produce the goods necessary to send to another country to actually increase the value of the dollar if it was falling too fast, and it’s because of these structural issues I mentioned.
What happens is the dollar goes down faster if it were to lose reserve currency status.
This creates more expensive goods because we have to import all these things from other countries that allow us to consume, and as the dollar goes down in value, those imports get more and more expensive.
Our standard of living goes down further.
Now, you may think the government would come in and start spending, especially in today's environment where the Republicans and the Democrats, whether you're on the left or right, the one thing they all favor is more government spending.
The problem with this is it creates all these high deficits or higher and higher deficits.
If you look at the deficit as a percentage of GDP, prior to the Covid-19, it was over 5%.
We have never seen levels that high, unless we were in a recession. And you hear on Fox News or Trump's Twitter feed, it's the greatest economy in the history of mankind. I don't think so.
So what happens to the deficits now?
Who's going to buy the treasuries that would allow the government to spend even more money to fill the gap that's been created in consumption by consumer goods rising in price while we're having de-globalization and all these supply chains trying to come back to the United States?
Trying is the key word.
Look at this government spending chart so you can really get our minds around this.
As we can see, the current government spending is 50%, or almost 50% of GDP, but this chart was prior to the Covid-19.
So I think it's safe to conclude that now government spending is over 50% GDP.
Let that sink in for a moment.
That means that over half of our economy is a result of the government, not the private sector.
And right about now your friend and family member Fred would step in and said, “Oh, George is just fear-mongering. That's nonsense.
The foreigners will always buy our debt. There will always be a bid for treasuries.” Not so fast!
Look who is currently buying the treasuries, and look at what has happened.
The amount of purchasing from the foreigners has really leveled off, but the Fed buying has gone parabolic.
This shows us that all the additional debt the government is issuing by running huge budget deficits is being purchased by the Fed.
They're just printing up funny money and giving it directly to the government. We call that monetizing the debt. Yes, that is what they do in Banana Republics.
If another country or central bank tried to do what we're doing, their currency would just plummet.
- You can ask, “Well, why hasn't that happened in Japan?
- Why hasn't it happened in Europe?”
Because they produce things. They export things to other countries, which creates demand for their currency.
Now, I'm not saying their economies are great. Their economies are just as bad, if not worse, structurally, than ours, but it's a much different type of problem they have.
The bottom line here is the end game is pretty much the opposite of what I explained.
- Rates will go up
- Debt will be more expensive
- We'll have lower asset prices
- The dollar will go down in value
- The goods we buy will become more expensive
This means we have to under consume as much as we have over-consumed for the past 40 years.
Until we're able to build back that manufacturing base so we can actually start selling goods to other countries.
The problem there is, if we look at China as an example, it took them 20 years to build this manufacturing base that we need and we've lost over the past 50, 60 years.
If it took them 20 years, how long is it going to take the United States?
Now, I would argue from an entrepreneurship standpoint, we have a huge edge, but we're going to see a ton of government regulations coming down the pipeline, especially if government spending is already at 50 plus percent.
All of the assets from the private sector are going onto the Fed's balance sheet. We're going to have less and less free-market capitalism, which means that getting back to our manufacturing is going to be harder on a moving forward basis.
And let's not forget that consumption is 70% of our economy. If we have to under consume for 10 to 20 years…
What is that going to do to the standard of living that we've enjoyed as Americans?
I'd like to point out one of my interviews with Jim Bianco, where he told us that the GFC, the amount of carnage we felt during the global financial crisis in 2008, 2009, was a result of economic output in the United States, going down by 6%.
So think about how much economic output would go down. If we had to under consume and the economy is 70% consumption.
It's not unrealistic to think that for a long period of time, our economic output would be at only 75%.
And that doesn't sound that bad unless you think about it through the lens of what Jim Bianco was talking about.
He not only discussed the GFC, but he also discussed the Great Depression of the 1930s, where economic output went down by 25%.
I'm not saying that the United States would have a deflationary depression if they no longer had the world reserve currency.
But what I am saying is, although there are no certainties, I think the probabilities would be high that we'd experienced stagflation for a long, long time.