Fifty years ago this Sunday, President Richard Nixon announced a bold economic plan, including the severing of the U.S. dollar’s ties to gold. Since then, the world’s monetary system has consisted of (mostly) freely floating currencies. The dollar nonetheless remains the primary legal tender used internationally for trade, finance, and as a store of value, which has conferred upon the U.S. enormous advantages. Whether that will continue for the next half-century is far from certain.
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In the half-century since the dismantling of the Bretton Woods system, the dollar remains dominant in the global financial system. Just as English is used throughout the world for business, the U.S. currency is overwhelmingly used for trade and finance. Indeed, the dollar-based global financial system is a major comparative advantage for the U.S. Unlike the classical example of England trading wool with Portugal for wine, the dollar itself is a major product sought around the globe, like Coca-Cola or Marlboros.
This has provided the U.S. with what critics call an exorbitant privilege. The demand for greenbacks to use for trade, finance, and reserves allows America to easily finance both its deficit in international trade and the government’s budget gap.
Indeed, the absence of constraints on the dollar and other currencies has resulted in an explosion of debt worldwide, says Jim Reid, head of thematic research at Deutsche Bank.
That reality has pluses and minuses. It allowed the U.S. and other governments to respond with unprecedented speed to the Covid-19 pandemic. “There is no way we could have locked down economies, and furloughed employees in the pandemic under a gold-based system. Lockdowns would have been highly deflationary and depressionary,” he says in a client note.
Yet, as economist Robert Triffin pointed out in the 1960s, Washington must have a balance-of-payments deficit to emit the dollars the rest of the world needs for trade and finance. Paradoxically, if the dollar supply becomes so excessive that the world loses confidence in the dollar, it will cease to be the world’s reserve currency.
That could happen as a result of running huge deficits and printing money to cover them, which Reid posits could be necessary to pay for government actions to fight climate change short of extreme taxation.
“It might help save the planet, but maybe at the end of it, fiat money might find it more difficult to survive, given the compound effect of the extreme waves of deficits and money printing seen over the last few decades,” he says. “Inflation is very easy to create if you spend and print enough money. What we don’t know is what that tipping point amount is.”
To MacroMavens’ Stephanie Pomboy, that tipping point feels close. The Fed’s money printing that has helped pay for enormous U.S. budget deficits has resulted in inflation that appears to be more than transitory. She sees that putting pressure on distressed corporate debt, as well as on consumers who have to boost their borrowing to keep up with rising prices, she writes in her latest missive.
There’s another problem. If the bubble in stock valuations pops, the $6 trillion shortfall that Pomboy calculates in public and private pensions would worsen. After bailing out Wall Street via huge monthly bond purchases, can the government refuse to bail out Main Street by having the Fed print still more money? “How will the rest of the world respond to seeing the reserve currency debased in such a swift and egregious manner?” she asks. Already the dollar’s share of global currency reserves has dropped, from around 72% at the turn of the century to under 60%.
Even so, the alternatives that might supplant the greenback for the world’s trade and finance aren’t obvious. ...