Lately we’ve been hearing a growing chorus of concerns about the possible collapse of the greenback.
Are those concerns ill-founded? Well, not entirely. But, hey, it would take an economic perfect storm to actually collapse the U.S. dollar. For that to happen a particular set of dynamics would first have to come together. So far, only two such are in place that could cause problems.
They are U.S. debt, and dollar weakness.
During the past decade, U.S. debt grew from $5.9 trillion to $14.3 trillion; and during that period the dollar lost 40 percent of its value. With other countries holding $4.45 trillion of that debt, of which China holds $1 trillion and Japan $907 billion, it’s understandable that there is some unease about.
If there were to be a panic, and foreign dollar holders rushed to sell them off and no one wanted to buy, then the U.S. dollar would collapse spectacularly. But that’s an unlikely scenario at this time, unless a major holder of dollar denominated assets, China, for instance, led the charge. But it would not be in China’s best interest to bankrupt its major trading partner.
However, there is another dynamic which, if put in place, could spark a dollar collapse.
With America deep in debt, nationally and internationally, the dollar’s value — such as it is — depends on its continued function as the reserve currency for other nations. In accordance with an agreement made in 1940, the oil producing countries of OPEC sell oil only in U.S. dollars. So anyone who wants to buy oil must keep healthy reserves of U.S. dollars. This means that America is the only producer of international currency. Which also means it can buy whatever it wants with new money, without having to produce the equivalent value in goods.
So it finances its international deficit simply by printing new money and spending it into circulation.
But — and it’s a big but — it would no longer be able to do that if the rules were changed to allow the world to pay for its oil in currencies other than U.S. dollars. In that case, the dollar would buckle under America’s debt burden and crash.
One analyst has described the effect of such an event on America’s economy as the financial equivalent of a nuclear strike. But then the rule-changers, and indeed the entire rest of the world, would quickly find themselves engulfed by the fallout — leading to grave economic consequences, probably even a world depression. You can’t destroy the biggest economy in the world and just walk away.
And that is probably why for the last decade there has been nothing but talk about switching the sale of oil from dollars to euros.
There will surely be changes. But slow changes. Probably a time will come when a basket of currencies, which will include the U.S. dollar, will replace the present system. Meanwhile, it’s up to the U.S. to do something constructive about its unsustainable debt burden, while there is still time.