The Attack on the US Dollar

Over the past month there has been numerous events which challenged the US dollar (USD) as the world’s reserve currency. Before we get into those events, here some background on the USD.

What is a reserve currency?

Simply, a reserve currency is a large quantity of currency maintained by central banks to prepare for investments, transactions, and international debt obligations. A large percentage of commodities, such as gold and oil, are priced in the reserve currency, causing other countries to hold this currency to pay for these goods.

How does it work?

Analogy - There is two countries who have unstable currencies that want to buy things from each other. Both countries don’t trust the other country’s currency (because its unstable) so they use a reserve currency (USD). They trade their currency for USD and then buy the commodity they want from each other. The countries can then take the USD and convert it back into their currency if they want to.

Why is the US dollar the world's reserve currency?

The USD is considered one of the less risky currencies in the world and is backed by the full weight of the American government and American economy. It took over as the world’s reserve currency after WW2 when the US economy controlled a large portion of the world’s GDP or economic output. Currently, most commodities are priced in USD and make up nearly 60% of global foreign exchange reserves.

Events that challenged the US dollar.

Over the past month there have been numerous different events, from different countries, that challenged the USD.

• Saudi Arabia and China to build refinery for 83.7 billion Chinese Yuan ($12.2 billion).

• China and France complete first LNG trade using Chinese Yuan.

• Russia considers using Yuan and reserve currency.

• China and Brazil agree to use Chinese Yuan to settle trade rather than US dollars.

• Saudi Arabia considers accepting Chinese Yuan for oil sales.

• Brazil, Russia, India, China, and South Africa (BRICS) announced development of a new currency.

• India says they will settle trade in Indian rupees with certain countries rather than US dollars.

• Chinese yuan passes Euro to become Brazil's second-largest currency in foreign reserves.

• IMF data shows that Russia now has ~33% of all reverses in Chinese Yuan

• China and Russia agreed to use the Chinese Yuan as a settlement currency.

• Data shows that Russian companies issued bonds in Yuan worth the equivalent of more than $7 billion last year.

Is this a coordinated attack against the US dollar?

This seems to be the question no one in the media (outside of a few people) are talking about. Outlets have mentioned that countries are openly moving away from the dollar, all around the same time period, but no one is connecting the dots on why. Foreign governments just witnessed a banking crisis and collapse caused by rising rates. The decrease in use of the dollar (or de-dollarization) also causes rates to rise. Maybe foreign governments are trying to economically hurt us by causing rates to rise? These are questions that should be asked and discussed but aren’t.

The economic effects of de-dollarization.

If countries stopped using the USD as the world reserve currency, then there’d be more dollars in the system that nobody wants. This would cause the dollar to fall and become weaker. The fall would start slow and then pick up as more and more countries stopped using the USD (a snowball effect). The falling dollar would cause prices to jump for anything coming into America or anything valued in USD. Commodities like gas, food, lumber would jump over night and would ripple through supply chains. This would cause pretty much all prices to skyrocket and be passed to consumers. If foreign countries started getting nervous about the USD, they would not only sell USD, but things nominated in USD. Things like bonds, stocks, and treasuries would go first then American real estate and so on. Roughly 40% of American stocks are owned by foreigners and 30% of corporate bonds, meaning if foreigners started dumping them then prices will plunge. This will cause 401ks to lose tremendous value and drive-up borrowing cost for companies, leading to bankruptcies and so on.

Now, the odds of this happening are very small but it is worth noting due to the recent events in the news. The graphic above shows that the USD makes up 60% of global foreign exchange reserves. This is not a number that will easily change overnight. It might take years for this number to start moving negatively.

Cause of De-Dollarization.

If the dollar is the world’s reserve currency, then there has to be a reason why some countries are moving away from it. I’ve seen two general thoughts on why:

1. The amount of US debt.

2. Rising Rates

These are two valid reasons why foreigners and American citizens are moving into other currencies, Bitcoin, or gold. But what is the overlying issue that ties those two together?

Government deficit spending.

The government spending money it doesn’t have leads to debt, rising rates, and de-dollarization. If we want to fix these problems and not just keep prolonging them, then we need to cut “costs” as a country and balance our budget.

Follow us on Twitter @Hill_Households and @Freedomville_ for more day-to-day coverage.

Email us questions or reactions @[email protected]