The Dollar – King Rat Of Failing Currencies

The explanation for the sudden halt in global economic growth is found in the coincidence of peak credit combining with trade protectionism. The history of economic downturns points to a rerun of the 1929-32 period, but with fiat currencies substituted for a gold standard. Government finances are in far worse shape today, and markets have yet to appreciate the consequences of just a moderate contraction in global trade. Between new issues and liquidation by foreigners, domestic buyers will need to absorb $2 trillion of US Treasuries in the coming year, so QE is bound to return with a vengeance, the last hurrah for fiat currencies. However, China and Russia have the means to escape this fate, assuming they have the gumption to do so.


It may be too early to say the world is entering a significant economic downturn, but even ardent bulls must admit to it as an increasing possibility. Financial analysts, both bovine and ursine, face a complex matrix of factors when judging the future effect of any downturn on currencies, and of the prospects for the dollar in particular. 

Some will take the view that a global downturn will continue to drive foreign currencies to be sold for dollars because dollars are perceived to be less risky and required to repay debt. Some will point to the tension in the euro from the extra twist an economic downturn gives to the debt crisis forced on Italy and the other three PIGS, compared with the relative stability of the Hanseatic nations. Some analysts will expect China to get her comeuppance when her debt-fuelled economy implodes into crisis.

As a recession progresses, it is conventional to think of the dollar as a safe-haven. For a brief time, relative to other currencies this might be true. But what then?

Those that succeed in their analysis beyond the short-term will do so by discarding all bias. They could then observe that in the event an economic downturn gathers pace a split could emerge in relative outcomes between East and West. The effect of a downturn on the Asian bloc, led by China, Russia and now joined by India, is likely to differ from the effect on America and Europe. It is the new versus the old, Asian mercantile states that provide minimal welfare, differing from the more mature welfare-heavy nations.

When we consider these two groups, we tend to analyze the situation through the lens of our own prejudices. Remove this predisposition, and it should become clear that whatever the starting point in terms of debt to GDP and other metrics, the prospects for welfare-light nations are considerably better in a global economic downturn than they are for nations burdened by extensive welfare obligations. China and other Asian states will not face the same degree of debt escalation as America, Japan, the UK, and the European nations. Furthermore, Asia has far more dynamic economies with the potential for a continuing industrial revolution. 

Government finances will be central to outcomes. Given that all government finances deteriorate during economic downturns, the starting point and the pace of debt escalation are what should concern us. China’s overall debt to GDP ratio at approximately 260% compares with that of the US which is around 360%, so on that score, China’s total debt is significantly less. The US Government’s debt to GDP stands at over 100%, while China’s is estimated to be under 45%. Yet, Western analysts perceive China to be in a weaker debt position than the US. 

America’s principal strength, which everyone cites, is the reserve role of her currency. Everyone needs dollars. All countries without sophisticated financial markets in their own currencies borrow in dollars, which must eventually be repaid. Everything from commodity prices to global financial markets is referenced in dollars. The dollar has also become weaponized, the means of enforcing America’s foreign policy. It is the King Rat of the currency world.

So long as the world enjoys continual economic growth, the dollar is difficult to challenge. When the economic tide turns, everything becomes different. In this article, I explain why the global economy is heading for a crisis which could be similar in scale to the great depression. If this analysis is correct, then the dollar’s prospects as the global reserve currency, even its continuing existence, will be threatened and must be reassessed in that light.

Peak credit is coinciding with trade protection

In a previous article, I pointed out the catastrophic danger of combining trade protectionism with the top of the credit cycle. This combination was devastating when the Smoot-Hawley Tariff Act was passed by Congress in October 1929, particularly when compared with the relatively minor consequences of the Fordney-McCumber tariffs of 1922. The difference was Fordney-McCumber was introduced early in the credit cycle, and Smoot-Hawley at its peak. This dissimilarity was the principal driver behind the viciousness of the Wall Street crash and the subsequent global depression.

We have a situation today so similar to Smoot-Hawley and its coincidence with the top of the credit cycle in 1929 that we should be deeply concerned. What is particularly alarming is that international trade appears to have already stopped expanding, almost as if it has run into a brick wall. A comparison with the 1929 experience suggests this result as extremely likely. That precedent warns us today’s international trade may be rapidly sliding from expansion into severe contraction, with dire consequences for the whole global economy. Smoot-Hawley and the top of the credit cycle in 1929 combined into the motive force that made the great depression unnecessarily deep, global and intractable.

The impact on government debt funding will be immense

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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