Credit goes to the intelligent u/peruvian_bull as the author of the below.
(this is a second half of Pt 1 of the endgame series, find the first half of Pt 1 here)
Updated Complete Table of Contents:
Part 1.5: Triffin’s Dilemma and the New Rome (YOU ARE HERE)
Ok, let’s go over this for a second. Let us say you are the President of a country like Liberia, a small West African nation, looking to enter global trade. You go talk to the International Monetary Fund, whose economists tell you in order to be a modern economy you need to have your own currency. Thus, you need a Central Bank to print your own currency (LD), which will be used as legal tender, enforced by your government. Your Central bank will act as a lender of last resort for all the commercial and investment banks in your country, and will be responsible for stabilizing monetary policy.
But, there’s an issue-the economists tell you that you CANNOT have your Central Bank store up your own currency as the majority of its foreign exchange reserves. Why? Well, if your currency comes under attack in the global Forex markets, you will have to defend it. If your currency trade value is too high, it’s easy to fight- you just print your own currency and buy Euros (EU) or Dollars (USD), flooding the market with your currency and taking other currencies out of the market- “devaluing your currency” .
However, if the inverse is true, and your currency is losing value in the market, printing more to flood the market will only make it worse. You need a stable currency, like bullets in the chamber, to utilize to buy your currency at the market rate, to support its value and drive it back up. This form of currency defense is called “defending the peg” (Post-1971, the peg is floating, so it’s more of a range, but it’s still referred to loosely as a peg).
This exact phenomenon played out during the Asian Financial Crisis of 1997, a classic case study in global monetary crises. Thailand had grown rapidly as world trade boomed in the 1980s and 90s, and its corporate and real estate sectors took on massive amounts of debt. A massive real estate and financial bubble formed (does this sound familiar)? Soon, the bubble started to pop:
Thai Financial Crisis
Thailand’s hand was forced, and the Thai Central Bank decided to devalue its currency relative to the US dollar. This development, which followed months of speculative downward pressures on their currency that had substantially depleted Thailand’s official foreign exchange reserves, marked the beginning of a deep financial crisis across much of East Asia.
In subsequent months, Thailand’s currency, equity, and property markets weakened further as its difficulties evolved into a twin balance-of-payments and banking crisis. Malaysia, the Philippines, and Indonesia also allowed their currencies to weaken substantially in the face of market pressures, with Indonesia gradually falling into a multifaceted financial and political crisis.
Asian Financial Crisis
As the president of Liberia, you see what can happen when a country, especially a small third-world country, doesn’t have enough dollar reserves to defend its own currency. Rippling currency devaluations, inflation, social and political unrest, widening economic inequality- the beginning of a death spiral of a country if you aren’t careful.
So, you tell the IMF that you agree to their terms. They impress upon you that you need to get your bank to buy up some other stable currency to hold as reserves, to defend against this very scenario. As the US dollar is the World Reserve Currency, you’re going to hold it as the majority of your reserve position.
We’ve established the need for a small country to hold another currency on their balance sheet. If ONE small country does this, there is little impact on the US Dollar. However, under the current system, virtually EVERY country has a central bank, and they all use the Dollar as their main reserve currency. This creates MASSIVE buying pressure on Treasuries. Using Liberia as an example, the process works like this:
THIS is what French Finance Minister Valéry Giscard d’Estaing meant when during the 1960’s he had contemptuously called this benefit the US enjoyed le privilège exorbitant, or the “Exorbitant privilege”. He understood that the United States would never face a Balance of Payments (currency) crisis (*AS LONG AS THE USD IS THE WORLD RESERVE CURRENCY*), nor a debt crisis, due to forced buying of Treasuries (from Central Banks) and Dollars (from Petrodollar systeem).
The US could borrow cheaply, spend lavishly, and not pay for it immediately. Instead, the payment for this privilege would build up in the form of debt and dollars overseas, held by foreigners all around the world. One day, the Piper HAS to be paid- but as long as the music is playing, and the punchbowl is out, everyone gets to party, dance & drink to their hearts’ content, and the US can remain the belle of the ball.
Effectively, the US can print money, and get real goods. This means we can import consumer products for cheap, and the inflation we create gets exported to other countries. (ONE of the reasons why developing countries tend to have higher inflation). Another way to explain it:
Exporting Inflation, importing goods
As it is the WRC, other countries’ Central Banks NEED to have US dollars on their balance sheet. Thus, the US has to run persistent current account deficits in order to send out more dollars to the global system, on net, than it receives back. A major byproduct is constant large and increasing trade deficits for the WRC holder (in a fiat money system).
This is what is known as Triffin’s dilemma: the WRC is HAS to run constant trade deficits. There are no immediate negative impacts, but in the long run this process is unsustainable, as the WRC country becomes unproductive (ever wonder why US manufacturing left) because the system forces the WRC holder to be a net importer.
As world trade grows, the current account deficit/trade deficit grows, and the benefits (more goods to the US) and drawbacks (more dollars build up overseas) increase over time. Eventually the imbalance becomes so great that something snaps, just like it did for the Pound post WWI, where policymakers chose the route of deflation in 1921, creating a Great depression for the UK long before the US ever experienced it.
US Trade Deficit broken down by Goods/Services
This is why I laughed out loud when I heard Trump rail against our trade deficits in one of the 2016 presidential debates. He clearly did not understand how our system works, and that this issue was beneficial in the short term, but detrimental in the long term. Our trade deficits were symptoms of our system working exactly as intended.
In fact, a large part of the reason why he was elected was the de-industrialization of the American heartland, where loss of economic vitality from manufacturing jobs was leading to rampant drug abuse, depression, and societal decay. I knew this process of deindustrialization would only get worse with time, and nothing he did (short of taking us off the WRC status) would change that. (Not political, other politicians say the same shit. They just don’t understand the very system in which we operate).
Fast forward to today- After decades of this process playing out, Foreign Central Banks collectively hold huge amounts of Forex reserves, as you can see below where countries are sized depending on their reserves of foreign currency exchange assets:
Central Banks FX Reserves
The majority of these reserves are held in dollars, mainly in the form of Treasuries, T-bills, and other US government debt. Furthermore, the US Dollar continues to dominate global trade through the SWIFT network (Society for Worldwide Interbank Financial Telecommunication). SWIFT is a payments system used by multinational banks, institutions, and corporations to settle trade worldwide.
USD is the preferred payment method within the system, thus forcing other countries to adopt the dollar in international trade. This is one of the results of the petrodollar system we described earlier. Petrodollars originally were exclusively used to refer to oil contracts priced in USD from Saudi Arabia, but over time the name grew to mean any oil contract, transacted by non-US countries, using the US Dollar as the denomination.
Most FX Reserves in Dollars
When Chile and South Africa trade copper, for example, they have to transact in dollars, because a SWIFT member bank in South Africa will not accept Chilean Pesos as payment, as there is a smaller, less liquid market for it and it doesn’t want to take a trading loss when converting to a more usable currency. The contract itself is priced in USD, so if that merchant bank wants to sell it, they can quickly find a buyer. In fact, SWIFT itself published a report in 2014, and found that the USD accounts for almost 80% of all world trade! (see top left)
Currencies as a % of Trade
This process is called dollarization, whereby the dollar is used as the medium of exchange for a contract, in place of some other currency, even between non-US trading partners (Iran and China for example). Dollarization (capital D) of a country occurs when a government switches from managing their own currency to just using the US dollar for trade settlement and tax revenue- like Ecuador, El Salvador, and Panama have done.
The US Dollar reserves from the petro-dollar system show up on the balance sheets of these overseas financial institutions; they are called Euro-Dollars, and these USD denominated deposits are not under the jurisdiction of the Treasury or Federal Reserve. If you want to read a brief history of the Euro-dollar market, check out this paper from the Federal Reserve bank of St. Louis here. In 2016, the total value of the Eurodollar Market was estimated to be around 13.83 Trillion.
Through this process, the United States was able to become the largest and most dominant military force in the history of man, able to fight simultaneous two-theater wars with overseas supply lines. The Treasury could borrow and spend, unimpeded by the normal constraints of market discipline that were hoisted on other countries. Despite not declaring war since 1941, the US has been in a state of near-continuous warfare.
American Military Budget
At every turn, the US defended this system at all costs, even going so far as to directly invade and occupy the Middle East in the Gulf War in 1991 and the Iraq/Afghanistan War (2001-Present). As a result there are over 800 US military bases around the world, in locales ranging from Turkey to Japan. American institutions like the Senate, Presidency, and Courts were modeled after their Roman antecedents, to the point that the American symbol, the Eagle, is the spitting image of the Roman Aquila adorned on the Standard of the centurions.
Most scholars tout the story of Rome as a tale of triumphalism; of valiant centurions battling in the steppes of Asia, of brilliant generals laying traps for enemy armies, of scheming senators fighting battles of political intrigue, and of a sophisticated and well-functioning empire that harnessed engineering to create marvels such as the Colosseum and the Roman Aqueducts. More sober historians, however, point out that the story of Rome is one that also echoes a warning through the annals of history.
A complex society, with mighty political, legal, and financial institutions, supported by a massive military, fell not to a crushing enemy invasion, but to collapse and decay from within. An elite ruling class, detached from the realities of daily life of the citizens, oversaw an empire with growing income inequality, environmental degradation, political corruption, social deterioration, and economic despair, and did nothing to stop it.
The Roman Treasury, facing insurmountable debts from years of fruitless war, started “clipping coins” an early form of currency debasement that led to the Roman denarii losing 25% of it’s value every year. This eventually led to uprisings in Roman provinces and the Sacking of Rome– the coup de grace, the final nail in the coffin for what had become the decadent Western Roman empire.
Smooth Brain Overview:
Petrodollars: Oil contracts priced in dollars means foreign companies need to have dollars to buy oil. This creates artificial demand for dollars as companies sell their local currency to buy USD.
Triffin Dillema: As the US is WRC, other countries’ Central banks need USDs. US thus runs deficits to push more $ out to the world to satisfy demand. This means cheap goods in the short term, but debt/dollar buildup overseas long term. Because of this, no country can remain WRC holder forever.
Eurodollars: Due to the petrodollar system, USDs build up in overseas bank accounts. These dollars are used by SWIFT for most international payments, and are called Eurodollars (due to the fact that most US dollars after WW2 ended up in Europe). The size of this market is roughly $14T.
Foreign Exchange Reserves: Due to the Triffin Dilemma & structure of WRC system, dollars build up in reserve accounts of foreign central banks. Wanting to earn interest on this cash, CBs invest in treasuries, effectively lending to the US Govt at low interest rate. $4T of these treasuries are held by these CBs, and $2T of these treasuries are held by private institutions.
If the US loses World Reserve Currency status, two things happen. 1) Foreign central banks start massively dumping their huge Treasury/Dollar debt positions and 2) SWIFT member banks who hold USDs for cross-border payments (EuroDollars) decide to dump them as they see the writing on the wall and see the value of their assets decreasing by the day. This is the one of the many Swords of Damocles hanging over the global financial system.
The unraveling of these massive currency positions would truly be catastrophic. Interest rates could effectively jump to +30% or more overnight, creating an immediate solvency crisis for the US Government and most banks, corporations, and state governments who rely on low interest rate borrowing. DXY would be whipsawed violently before being forced downward by massive selling pressure from the Eurodollar market. Other currencies would be pulled higher and then lower in volatile moves matching the worst days of the early Nixon crisis. But, this is only part of the story. We will come back to this later.
We’ve gone over a brief history of the Bretton Woods system, and it’s transformation to a complete fiat money system starting in 1971. The US as a World Reserve Currency holder is allowed to borrow almost indefinitely without immediate consequence, but this creates massive amounts of US dollar debts overseas. The last time global creditors started to lose faith in the US dollar, we saw massive inflation, unemployment, and stagnation in the US, in a period of rapid demographic and economic growth in the rest of the world. If creditors become worried again, and signs are showing up that they are (more on this in PT4) the results could be catastrophic.
(Adding this to clear up FUD- My argument is for hyperinflation to begin in a few years- this is a years- long PROCESS, and will take a long time to play out. It won’t happen tomorrow, but we are in the same situation as Germany after WW1. Hyperinflation is GOOD FOR GME— DEBT VALUE COLLAPSES, MONEY CHASES ASSETS (EQUITIES) pushing the price UP, so shorts will have to cover) BUY AND HOLD.
Nothing on this Post constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading my Post I cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Post are just that – an opinion or information. Please consult a financial professional if you seek advice.
*If you would like to learn more, check out my recommended reading list here