The reign of the dollar for international investors has been a mainstay and familiar guide post. The United States dollar (USD) has been a currency that all sides could agree had value. It was relatively easy to convert in most countries and ended up being legal tender throughout the world. A great deal of world trade both legal and illegal ends up being negotiated with American dollars.
The continued and rising demand for the currency of the United States because of the need for dollars to purchase oil on international markets, has been a pillar of trade since the mid 1970’s.
The introduction of the petrodollar introduced by the United States was a stroke of genius by the Nixon Administration. The President and his Secretary of State Kissinger needed to stoke new demand for USD following the breakdown of Bretton Woods in 1971.
The grand deal negotiated was simple enough. The United States would protect Saudi Arabia militarily and provide the kingdom with advanced weaponry. In exchange the Saudis would factor their oil in USD period. As the dominant exporter of oil in OPEC (Organization of Petroleum Exporting Countries) other nations soon were forced to follow suit.
The second part of the deal was for Saudi Arabia (and soon other nations of OPEC) to take the surplus of money generated by the sale of oil and invest it in the debt and securities of the United States.
The nations of OPEC were willing to make this trade because this investment seemed sound for the decades to follow and it provided military protection for aggressors in the international arena. It was no accident, that numerous American military bases were to spread out in the Persian Gulf. Hint, this is where the oil is.
The purchase of American debt allowed the United States to become a true superpower in every sense of the word. It became supreme in military might, economic power, and as a result political influence. American diplomats could virtually buy American influence when and where it was needed. This was all largely because of the petrodollar.
The petrodollar allowed American political leaders the ability, at least for a time, to offer Americans of the late 20th century both options; an all-powerful military and an expanding entitlement society.
What many Americans refuse to recognize is that much of what is expected and demanded of the government is not affordable under the present tax structure. Government payouts in social spending is not limited to the underprivileged but has become commonplace across the middle class as well.
If one looks at the primary budget deficit of the United States it is easy to see the dilemma. It is either the military or continued social spending. The country even a superpower as compelling as the United States, cannot afford both indefinitely. It shows the irresponsibility and immaturity of the American political class across the spectrum. As each new entitlement is passed there is no real attempt to pay for it. What the big lie is and has been; that the American middle class life style is affordable. It has created an illusion of power, prosperity and wealth that is the product of debt.
The American Empire is following the path of so many other great nations of the past. The United States at present has too many military and treaty commitments, an entitlement mentality among its citizenry, and now a rapidly deprecating currency.
Britain as the premier power of the world in the early 20th century faced the same choice after World War II. An expanding entitlement society or the Empire. In the late 1940’s and 1950’s the choice was made. Britain soon faded as a first rate military power. The rest of Western Europe followed the same path. The attitude of many politicians of the time was that it was perhaps,for the best. Past expenditures on the military had led to two ruinous World Wars, largely fought in Europe and to the great detriment of the citizenry. Besides, the new superpower to the west (The United States) was now going to protect them.
The United States sits atop of a financial scheme based on debt and the continued ability to print more USD to finance the interest on that debt. It is the only nation that can print more money without immediate consequences. This is only possible because it is the reserve currency of the world. It allows the United States to export the cost of debt. It also allows Americans to continue to import massive quantities of goods and services that would not be affordable otherwise.
If you notice even those politicians in the United States who preach fiscal and spending restraint only talk about a primary balance in federal spending. There is no real plan to pay down the huge debt accumulated over the past generation. The excess of $17 trillion USD is just a number to many people. Unfunded liabilities are far greater in sum. In truth, the recent trend is to continue to add to entitlements. Many American politicians in fact, act like the responsible thing is to continue to increase the debt level, on a regular basis. These individuals are either dishonest or living in a fantasy world, or maybe both.
Without a constant and perpetual growing demand for USD the present debt based financial system will collapse. If demand slackens the trillions USD now held by foreign commercial and central banks would start being unloaded. This would create hyperinflation in the United States as institutions around the world dump the dollar for other currencies and assets of value.
The United States through the Federal Reserve would have no choice but to increase interest rates possibly well over 10%, in attempt to save the currency. Interest rates of this kind would bring down the American economy. The housing market would virtually collapse and US consumption would come to a standstill.
That would just be the beginning. With job losses mounting along with even more debt being accumulated, the interest on government liabilities would now become unaffordable. There would be a rash of foreclosures and bankruptcies across the US economy as the government itself, becomes insolvent. The misery that would follow would bring the American people to a reality, that would more resemble the Great Depression, than any other set of events since that time period.
As an investor you may be asking if this will happen? The answer is not if, it is when? At this point there is no saving the United States currency, despite its premier role in international trade and investment. As a debt based currency it will not survive a world of declining production and growth.
Many investors on a global scale are now losing faith in paper currencies. Monetary authorities around the world are already discussing the need for a new currency system and order based on assets like commodities. Gold and possibly silver are the most likely candidates, given their scarcity and history of stored value. These two metals have been a source of money for thousands of years.
Other forces are also working against the United States and the international role of the USD. Russia, China and Iran are already holding meetings how to bypass the use of the dollar in bilateral trade. In addition, other nations are calculating what the new economic order will be post dollar. They are taking steps to prepare for this eventuality with a greater urgency than in the past. This will be the topic of the next article in the series on the United States Dollar.