The reason USD became the world’s reserve currency is that America has had the largest, strongest steadily growing and conservatively financed economy and a stable political system anchored in the US Constitution.
Yet for USD to continue to be valued, the world has to believe in it.
Since the end of World War II that has been the case. People basically looked at the US and many of them concluded that it was the safest place to keep their savings.
They did not have to worry that if they put their money in the USD it would lose its value. The USD was not going to be diluted by hyperinflation or burned up by a foreign or civil war.
The US political system was stable and strong, and people did not have to worry that at some point they would not be able to take their money out of US banks.
The problem with being the envy of the world is that it changes your behavior.
You start believing that you are very special for reasons that are not grounded in reality. You start believing that bad things happen only to other people and nations because they are not as special as you.
You can do anything you want, borrow and spend as much as you like and nothing bad will happen to you. This behavior in turn starts to undermine the core reasons why people trusted your country and currency to begin with.
This is what is happening to the US now.
In Y 2020 the ratio of US debt to the output of the economy (debt to GDP) is likely going to exceed 120% (and might be as high as 130%). You can blame the C-19 coronavirus chaos for some of that, but the national debt has been going up steadily. The US has run huge budget deficits in bad times and in good, long before The China Virus.
In Y 2000, U.S. debt was $6-T, a 30% debt to GDP ratio. It was $14-T in Y 2010 and $23-T in Y2019, increasing $1-T a year while the US economy was booming. The US was charging $1-T a year, year after year, on its national credit card to buy things and to engineer this growth.
By Y 2019, 10 yrs after the Great Financial Crisis, the Fed was still running its policy of QE. Debt to GDP at that time topped 100%. We have not acutely felt that debt burden, because interest rates declined over the last 20 yrs.
Then C-19 coronavirus happened
So far the US has spent 12% of GDP to keep its economy afloat during the shutdown, 2X as much in terms of GDP as the rest of the world, 4X as much as the largest European countries, 3X as much as Japan.
Our debt has skyrocketed by perhaps another $6-T. The Fed already owned $2.5-T in US government bonds in Y 2019, and now it owns $3.7-T worth and is a buyer of US corporate bonds and ETFs. Stocks may be next.
With that, credit rating agencies have put AAA-rated US government debt on “negative watch,” signaling a possible downgrade.
Countries that borrow in their own currency do not default on their debt, at least not by failing to make payments. Instead, the U.S. would “honor” its obligations via massive money printing, which could bring massive inflation and hammer the USD.
The large debt pile is just part of the story.
In the largest economy in the world, the staunchest advocate of free markets, the cost of money, the most important commodity is set by 12 economists
In Y 2020 the social fabric of American society is coming apart. Each time we think the toxicity of our politics cannot get any worse, it does.
Unlike in the country that came together during World War II or 9/11, this time the C-19 coronavirus has pulled Americans further apart.
The USD is unlikely to lose its reserve currency status in the near future for no other reason than that there are no better alternatives the strength the USD has experienced over the past 10 yrs is fading.
And so now professional investors reluctant to buy gold in the past are buying it now.
Gold hedges their clients against 2 scenarios: a weaker USD and the debasement of all currencies, as USD declines and so do other currencies. Dollar outflows will be looking for homes. Some money will flow into Euros, GBps, and Swisses, and some into gold the incorruptible asset class as central banks and politicians cannot create more gold.
Gold then becomes just another position in the portfolios; a hedge.
Yes the US will have its challenges and will adapt, and investors will adapt too, the savvy 1’s started in December 2019.
Have a healthy week, Keep the Faith!
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