However, our problems are less with him and more with the people who have left him with such weak and unstable economic conditions.
Over the weekend, the incoming President sent a stern message to the BRICS nations, a group that now includes many more countries than the original Brazil, Russia, India, China, and South Africa. It includes US enemies such as China and Iran but ‘friends’ like India and the UAE.
Mr. Trump said bluntly:
“The idea that the BRICS Countries are trying to move away from the Dollar while we stand by and watch is OVER. We require a commitment from these Countries that they will neither create a new BRICS Currency, nor back any other Currency to replace the mighty U.S. Dollar or, they will face 100% Tariffs, and should expect to say goodbye to selling into the wonderful U.S. Economy.”
OK, what is all this about? This is not a story that has gotten much ink. Are we about to be plunged into an international trade war? The notion of global payment systems and currencies is a wonky subject and not very sexy. But it just happens to be important, even if it has never been discussed on “The View.”
The President about to be #47 has just threatened nine countries, big ones like China, Russia, and India. Why did he do it? He recognizes that the ability to fund US debt by selling it abroad takes place at low interest rates because the dollar is in demand as the world’s “reserve” and “transaction” currency. That means most countries hold dollars as their bank reserves, and most commerce is settled in US dollars.
This has been called the “exorbitant privilege.” It means that the US is the only country in the world that can inflate its currency to pay its domestic and international debt. Other countries are limited to the domestic side only. As such, this has given the US tremendous power in the global monetary system and can force others to subsidize our standard of living.
To understand, we need to rehash some history.
Our money was backed by gold and silver for most of US history. Our paper money circulated as a receipt for the metal “payable on demand at the US Treasury.” You could actually present your paper money and demand the real metal behind it. Although it had nominally, most of the time, 40% backing, the system basically limited the growth in the base money supply to the growth in gold and silver at the Treasury.
Our domestic currency arrangements also meshed well with the International Gold Standard, primarily put together by Great Britain, the era’s lead industrial and military power. Gold flowed back and forth among nations. If a country had too high inflation, gold would tend to leave the offending country, contracting its monetary base and causing inflation to fall. If a country suffered deflation, gold would flow to that country, expanding its monetary base. The system acted generally as a nonpolitical, market-based system of financial equilibrium. Most industrial countries adhered to this arrangement, and except for war, there was little inflation for 250 years.
This “classical gold standard” lasted until about 1914, when it broke down due to the cataclysm of World War I.
Attempts were made in the 1920s to return to the pre-war arrangements but were unsuccessful as the world had inflated dramatically due to the war and the suspension of the gold standard.
Many countries abandoned the gold standard entirely in the 1930s because of the worldwide Great Depression. The US ended the domestic side of the gold standard but hung on to remnants of the international gold standard.
In 1944, the soon-to-be victorious nations struck a deal at a resort in New Hampshire for a new post-war monetary arrangement. The treaty was named for the resort: the Bretton-Woods Treaty.
With the world in tatters, the new arrangement said the US dollar would largely supplant gold as the reserve and debt settlement currency. When held by foreigners, the US dollar could still be converted to gold on demand, so the system still had ties to gold.
This arrangement continued until the late 1960s but began to fray because the world doubted the US could pay for both the Vietnam War and the Great Society. In this sense, they were absolutely correct. Democrats were printing so many dollars that the world knew there could not be sufficient gold behind them. Countries began to demand gold for their dollars to ensure they were not the last ones left if the US ran out of gold. A run on the bank ensured, and US gold reserves fell very quickly. In August of 1971, President Nixon abrogated critical provisions of the treaty by suspending all convertibility to gold before the US ran out of the stuff. However, because of the size of the US economy and dependence on US military power, the world had little choice but to accept our terms.
Nixon and his advisors thought this treaty violation would be temporary, but economic and political trends prevented them from returning to old arrangements. Keynesian economics dominated the thinking of both political parties, and the idea of “permanent deficits” was in vogue. Inflation was considered a good “lubricant” for economic growth. But that was just academic cover for politicians spending more than they could reasonably collect in taxes, and the warfare/welfare state was launched. Getting rid of the last remnants of the gold standard gave politicians what they had sought for years: the ability to spend on all their pet programs. The hidden tax of chronic inflation would pay for government expansion.
Domestic money holders saw their value shrink, but many holders of US dollars abroad experienced the same thing. But their governments were just as bad spendaholics as the US. Their currencies lost value as well, and the gold price rose from its official price of $35 per ounce in 1971 to flirting with $2,800 per ounce today. In terms of many other currencies, the depreciation against gold has been even more severe.
All significant nations that run welfare states feel the severe distortions of demographic changes. Almost all major social entitlement systems are Ponzi-like schemes that can’t sustain themselves when the number of new babies born shrinks below replacement. There are fewer workers to support the exploding number of elderly who have been promised socialist-inspired pensions and medical care.
Thus, while many nations openly grumbled about the poor management of US finances and our abuse of the privilege of issuing the world’s reserve currency, there was little alternative to continuing with the US dollar. One attempt was the Euro, which has proven to be a big flop. Most Eurozone countries had as bad or worse financial policies as we have had. Thus, despite all its troubles, the US dollar has been the “cleanest shirt in the dirty laundry.”
However, that admits to a severe problem. All currencies are dirty rags and have not been good places to place money for long-term purchasing stability. Based on what the dollar was worth in 1914 at 100 cents, the end of the gold standard and the beginning of the Fed standard, the dollar is worth about three cents.
Believe it or not, the depreciation has been even worse in other currencies. Professional “management” by experts has been inferior to the previous system.
So, the world has limped along with a monetary system that has allowed chronic inflation. It has allowed socialists all over the world to pursue their schemes of redistribution, welfare state benefits, and wars that aren’t paid for. Nobody wants to fix the system, and proponents of the gold standard are considered monetary quacks. As financial historian James Grant has put it, we live with the PhD standard of “managed” money. We take the boom and busts and the falling value of money as the price to pay for all the extensive government services to which we have become addicted. Over 600 hundred economists work at the Federal Reserve. Surely, they know how to manage the world better than the autonomous, non-political features of the gold standard.
However, with US deficits spiraling entirely out of control and Keynesian policies on steroids (Modern Monetary Theory), the world is again worried about relying on such a poorly managed currency to serve both reserve and transaction functions.
Rather than just accepting the cleanest shirt in the dirty laundry regime, countries began to discuss creating a currency better than the US dollar. The initial formation of BRICS started in 2006 and was based chiefly on dissatisfaction with the dollar’s management.
Then, in February 2022, President Biden decided to seize Russian monetary reserves as punishment for their aggression in Ukraine. At the time, we wrote about the problem and said this was a big mistake that would have wide-ranging repercussions. Biden showed that the international monetary, payments and banking systems were all captive to US foreign policy. Just like Biden de-banked domestic political opponents and seized their credit cards, he now mobilized the international monetary system as a tool of US power.
For countries beyond Russia, like China and India, this showed that their investments in Western banks were not secure and could be seized at any time they might get into a foreign policy scrap with the US. They wanted an alternative system.
You can’t fault them, and Trump can’t demand other countries use a currency that melts in their hands and subjects themselves to the whim of Washington bureaucrats. Being the reserve currency issuer must be earned. Like respect, it is earned and can’t be “demanded.”
To some extent, we see the same motivation in proponents of cryptocurrency as we do with the BRICS nations. The issuer of the reserve currency indeed has tremendous privileges, but with that comes the responsibility to run an orderly system. Although Russia is no angel by any stretch, there was not even any legal process before seizing $400 billion worth of their money. Other countries took note, as we said they would.
J.P. Morgan famously said, “Gold is money. Everything else is credit.” If non-gold money is credit, it is only as good as the promise to pay from the issuer. Thus, the credit holder must worry about the debtor’s creditworthiness. If the debtor is a spendaholic, creditors have a problem. If you further make money and the credit system political and an instrument of war, holders of credit and currency have even more to worry about. These are some of the reasons central banks have been buying gold at the highest rates since the collapse of Bretton Woods. Gold is not a promise to pay and is not issued by a country.
So, Trump wants to stop the process of dethroning the dollar. We don’t blame him because we will all pay a high price if it is dethroned. He is the first politician in many years who seems concerned about the dollar’s unique status in the international payments system. It gives us tremendous advantages and unique responsibilities. For this attention, he deserves praise.
However, a better way is to make the dollar worth holding for the longer term and make the international payment system politically neutral once again. To borrow a phrase, we need to make our money great again. That means low inflation and sound finance.
Starting an international trade war and experiencing the collapse of the international monetary and banking system is a great way to start a global depression. Trump may need to tread carefully.
As we recently observed, many of our institutions have become corrupt and wandered far away from their original purpose. Money is one of those institutions. There is a good argument that we need a “disruptor” right now. Trump was hired to play that role. However, the world is a complicated place and very over-indebted right now. Disruption has its risks, and it may begin a chain of events with unknown consequences.
The best way to preserve the dollar’s status is not to threaten trade wars but to make the dollar great again.
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