A lot of people nowadays take for granted the assumption that our current global economic system will continue in its current state for many years to come. Unfortunately, doing so falls into a cognitive trap called recency bias. It can be especially tricky to avoid, because macro level changes in a monetary system tend to happen very slowly. As an example, the debasement of Roman currency began ca. 117 AD but didn't culminate until 337 AD.
However, this year presents a rare opportunity to educate people on the topic, as the "money printer go brrr" meme has been widely circulated, and more attention than ever has been placed on governments and how they financed extraordinary spending during the supposed pandemic.
Todays discussion will focus on one of the most important aspects of the economic system -- global reserve currency. From Wikipedia:
A reserve currency (or anchor currency) is a foreign currency that is held in significant quantities by central banks or other monetary authorities as part of their foreign exchange reserves. The reserve currency can be used in international transactions, international investments and all aspects of the global economy. It is often considered a hard currency or safe-haven currency.
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Economists debate whether a single reserve currency will always dominate the global economy. Many have recently argued that one currency will almost always dominate due to network externalities (sometimes called "the network effect"), especially in the field of invoicing trade and denominating foreign debt securities, meaning that there are strong incentives to conform to the choice that dominates the marketplace.
Enough background, onto the good stuff.
At the end of WW2 all the allied powers came together to find a way to facilitate international trade. The result of this was called the Bretton Woods agreement, whereby the USD was convertible to gold at a fixed exchange rate, encouraging countries to use USD for international business because of the stability related to a gold-backed currency.
However, the fixed exchange rate to gold did not last forever. In order to finance the long Vietnam War, the US printed far more dollars than it had gold to back. At some point foreign countries realized they were amassing large quantities of paper money and began to get suspicious.
In 1971, France and Switzerland both sent much of their USD reserves to the states for conversion into gold. The result was the so-called Nixon Shock, whereby the US unilaterally cancelled conversion between USD and gold. Naturally, Nixon sold this to the American public as protecting the stability of our currency. But, it did nothing of the sort.
The 1970s were turbulent for monetary policy. The stock market was a mess, interest rates were exorbitant (20%), and there was a major recession. This was all due to the Nixon Shock. Why?
Many foreign leaders had in their reserves large quantities of USD, as it was the de facto international currency. The cancellation of the link to gold brought severe devaluation to the USD and speculation for further losses, so no one wanted to hold it anymore.
In 1973 there was an oil embargo by the members of OPEC. It is my belief that this was retaliation for devaluing much of the money held in their coffers. Alternatively, it was simply an act of self preservation as they had not adjusted oil prices immediately following the Nixon Shock, despite the devaluations that had occurred, and they were concerned about further devaluations in a purely fiat world. Another theory is that it was payback for U.S. military aid to the Israelis during the Yom Kippur War.
Then in 1974 a deal was struck between Nixon and the House of Saud, to bring an end to the oil embargo. The Saudis would resume selling the oil to the west, only for USD, and the US would lift some economic sanctions that prevented the Saudis from investing in the US. Also, instead of simply stockpiling USD from their oil sales, the Saudis would invest their USD surplus into US debt instruments and capital markets. This is known as the Petrodollar Recycling system. With the Saudis breaking the OPEC embargo, other nations shortly followed suit, continuing to sell their oil for USD. The main benefit to the US is that the USD is still used as international unit of account, preventing collapse of the currency.
And so it was, with the birth of petrodollar system, that the aftereffects of the Nixon Shock began to settle down. King Dollar went unchallenged for a while after that. It wasn't until the formation of the EU and birth of the ECB/Euro that there was any real competition.
In the year 2000, Saddam Hussein, leader of Iraq, began selling oil in Euros. The 'legality' of this move was actually challenged by the US, due to sanctions put in place after the first gulf war. But, the U.N. confirmed Iraq's right to sovereignty. Also notable: the MSM mocked Saddam for this saying the Euro would depreciate badly against king dollar. Contrary to their predictions though, by 2003 Saddam's choice had actually paid off handsomely, as the Euro was doing quite well in FX markets. A short lived victory, however, as he was ousted and killed in 2006 by the US.
The next challenger was Gaddafi, who openly eschewed the western financial system, organizing a gold-backed, pan-African currency, and establishing an African infrastructure investment bank so that developing African nations did not need to pay interest to the World Bank or IMF. He was ousted in 2011 in a most violent and public way.
More recently, we have seen bilateral trade agreements pop up between Russia, China, and Iran, so that they do not need to settle their trade accounts in USD, further weakening the petrodollar system and "King Dollar." (See BRICS and the AIIB)
Lastly, remember when Saudi Arabia Warns of Economic Fallout if Congress Passes 9/11 Bill. This bill would have let victim's of 9/11 sue the Kingdom of Saud for material support of terrorism. The Sauds threatened to sell almost a trillion dollars worth of US debt instruments if this bill was passed, which would wreck havok on the US financial system, devaluing the USD and making it much more difficult/expensive for the government to borrow. It likely would have dropped the US credit rating as well. Note that the Sauds would not have had this power over the US if it weren't for Petrodollar Recycling.
That pretty much catches us up to present day, where we have seen a virtually unprecedented amount of money printing by central banks across the globe last year. Let's end by discussing some of the possible scenarios going forward.
One scenario is a simultaneous hyperinflation of all fiat currencies. Although drastic this is not out of the question. And in reality it might not actually be simultaneous, at first people could flee to USD before eventually figuring out their final exit strategy. This is actually a scenario we call the Great ResetTM -- although that the term has been coopted by WEF&IMF recently, it has been in prior use for many years in the circles I travel.
This scenario could end in a number of ways. It's possible a large nation like China announces gold backing of their currency during this event, increasing faith in their funny money and quite possibly capturing the role of global reserve currency. It fits too -- there have been reports over the last 5-10 years that both China and Russia have been stocking up on physical gold. I cannot speak to the veracity of those reports, for those curious I read them on ZeroHedge. I think the world at large would be foolish to fall for this scheme as we have seen how quickly a gold peg can fail (26 years in case of the Bretton Woods->Nixon Shock timeline)
Another possibility is that Bitcoin (or another cryptocurrency) becomes a widely adopted standard for international trade. I think this is the most logical thing to do, as it makes cents that the international currency should not be controlled by any one nation. However, just because something is the logically correct way of doing things, doesn't mean that will happen. Since Bitcoin would reduce the power of currency issuers, nations will likely fight it vigorously.
However, it is likely the central banks will adopt some form of blockchain technology, in order to release their own CBDCs -- central bank digital currencies. Many pilot programs are already underway around the globe. In a few ways these are better than paper money, e.g., counterfeiting is not possible. But in most ways, these are much worse for the end user -- more surveillance, censorship, and asset forfeiture. Best believe that CBDCs will not inherit the parts of blockchain technology that promote personal freedom.
One last possibility is the IMF promotes their SDR (special drawing rights) as the new standard for international currency. The SDR is effectively a basket of different state currencies, where each currency is somewhat proportional to economy size. This seems a likely possibility that all major banks could get on board with, because it ostensibly splits up power between them. This could also result in something like the SDR and a gold-backed Chinese currency competing for the spot of global reserve currency. Who knows.
Thanks for reading, I hope you enjoyed my post.
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