The Dollars Death? Not So Fast - Part One

There are four critical reasons why the dollar will not lose its global reserve status anytime soon.

Before sharing those with you, it's worth a brief history of reserve currencies and its lessons. Then you will better appreciate the problem with the dollar and why the its death is unlikely soon.

History of the dollar and reserve currencies

When explorers began sailing around the globe in the 1400s, demand for a common currency multiplied to facilitate global trade. Since then, international trade networks have flourished, and the need for one currency that all trade parties accept has become commonplace.

One currency accepted by trade partners alleviates the need for barter. Barter only works if both parties have something of value the other party wants. If not, one partner must then offload the goods they received in barter to another trade partner. Such can be awkward and expensive when dealing with large or cumbersome goods. It is also fraught with risks such as spoilage, theft, and fire, among other problems.

A reserve currency usurps barter trade by allowing a seller to accept currency in exchange for goods, hold the currency easily and safely, and then use it at their convenience to purchase goods from another party.

As the graph below shows, eight reserve currencies have existed since 1250. Each one before the dollar saw its reign end due to financial negligence. The dollar has been the world's reserve currency for a relatively short time.

Bretton Woods

Before the dollar, the British pound was the world's reserve currency. The U.K. was the largest exporter of goods and services and had the most advanced banking system, insurance offerings, and commodities markets. Its military strength helped as well.

The U.K.'s financial burden from World Wars I and II forced it to abandon the gold standard and nearly bankrupted it. Towards the end of World War II, the Allies realized that sustainable post-war economic growth, rebuilding, and peace required a more stable currency.

In 1944 at a conference of world leaders in Bretton Woods, New Hampshire, the dollar was crowned the world's reserve currency.

In Our Currency, The World's Problem, I provided more detail on the Bretton Woods agreement and its inherent drawbacks.

The dollar is following the doomed path of other currencies

In Our Currency, The World's Problem, I stated:

Foreign nations accumulate and spend dollars through trade. They keep extra dollars to manage their economies and limit financial shocks. These dollars, known as excess reserves, are invested primarily in U.S.-denominated investments ranging from bank deposits to U.S. Treasury securities and a wide range of other financial securities. As the global economy expanded and more trade occurred, additional dollars were required. As a result, foreign dollar reserves grew and were lent back to the U.S. economy.

Lending by other nations to the U.S. resulted in cheaper and easier funding for the U.S. government and its corporations and citizens. As shown below, the amount of debt expanded well beyond our ability to pay for it.

To help ease the pressure of being severely overleveraged, the Fed has managed interest rates lower than they would be otherwise. Easy monetary policy, including quantitative easing (QE) and negative real interest rates, promotes speculative behavior over productive investment. Consequently, economic growth further deteriorates, making debt more burdensome to service and requiring even easier monetary policies. The flawed circle of debt and growth has its limits. However, unlike the bankrupted British and French before the dollar, there is currently no worthy replacement.

Summary part 1

Peace and prosperity followed two world wars and a global depression, and the world needed a strong reserve currency. The dollar fit the bill, so to speak.

As I will detail in part two of this article, the rule of law, liquid financial markets, and economic and military might were traits that only the dollar had at that time.

While many years of relative peace and prosperity have transpired in the last 85 years, the economic landscape and military power have shifted. While there are many flaws with the U.S. economy and its dollar, the other options are not viable.

The old saying goes that the U.S. dollar is the cleanest shirt in the dirty laundry.

Michael Lebowitz is the founding partner of 720 Global and partner with Real Investment Advice. We assist our clients in differentiating themselves from the crowd with a focus on value, performance and a clear, lucid assessment of global market and economic dynamics. For more information about our upcoming subscription service RIA Pro, please contact us at 301.466.1204 or email [email protected].

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