The Collapse of the US Dollar: A Scenario

US Dollar September 2007
Things are worth what people think they’re worth. It’s all psychology. It was psychology that had the stock market trading at unprecedented multiples of earnings in 1929, and people believing there was no end to profts to be made, and psychology that caused a collapse that created widespread human suffering that lasted a decade and was only resolved by governments spending billions (they did not have) to fight the second world war.

Why are people willing to pay $25 for a CD, or $4 for a box of brand name breakfast cereal that costs only pennies to make? Because they think the price is fair, reasonable. That can change in an instant. The fact that used house prices soared to an average of over $300,000 (and much higher in many cities) despite the fact that you could build a house yourself for a fraction of that cost, was due entirely to psychology. People believed that prices would keep rising forever, so it was a good investment to pay 300% of replacement cost, because someone else would soon pay 500% of replacement cost. Especially when lenders would give you 110% of the money you needed to buy that house, with no payments or no interest for six months, even though you had no collateral for the loan except the house itself.

The Fortune 500 has been able to increase profits by double digit percentages for several years, mostly by buying up smaller companies and competitors, offshoring the labour costs, Wal-Mart-squeezing their suppliers for price reductions on materials every year, lowering quality and eliminating service. Pull off this magic trick enough years in a row and people will think you can do it forever, so they’ll pay more and more for stocks. Just like in 1929.

In order to fund all that offshoring, you need to either pay cash, or get the foreign manufacturers to loan you the money, denominated in your own currency, at next to zero interest rates. If you have no cash (because you aren’t producing anything yourself) you need to keep rolling over those debts. The countries doing all your manufacturing need to be confident that the dollars you’re promising, one day, to pay back, are worth something, and that there isn’t a safer or higher-yielding investment for their money than a big receivable from you in your currency. Or else they need to be so heavily invested in your currency that they don’t dare call in the debt, because they know that you couldn’t pay it — so they become co-dependent on you. Psychologically, you reach the stage where you both have to keep lying to each other, and to yourselves, that the risk is manageable, that everything is OK, as long as both of you keep your story straight.

And in order to keep the cost of oil, which drives your economy, down, you need to wage staggeringly expensive wars to secure most of the oil that is left. And to keep the stock market going when options to squeeze a bit more cost out of each product and keep profits rising run out, you need to massively subsidize the large corporations with taxpayer dollars, and reduce their taxes and regulations. To do that you need to convince the world that the staggering debts you’re piling up can be repaid from future increases in taxable income, that your insolvency is temporary. So you need to project endless huge increases in taxpayer wealth so that people aren’t panicked by how maxed out you are now. And the people have to believe that these future taxpayers — the current taxpayers’ children and grandchildren — will somehow be able to repay the monstrous debts you are burdening them with today. And of course, that interest rates will remain perpetually low, so that those debts don’t suddenly balloon even higher.

It’s all like a tightly wound spring, with all the screws holding it together ratcheted ever tighter, and the presumption that as the stresses on it increase, not only will it hold forever, but we’ll be able to squeeze ever more tension out of it. If one of those screws pops, the whole thing flies apart and comes undone. The bubble bursts. The dominoes fall. Just like in 1929.

The screw that is popping is the value of the US dollar, shown above. It is plummeting against all other global currencies, even though they are all increasingly interconnected. No one benefits from the collapse of any major currency, so it is in everyone’s interest to keep them all ratcheted up, in relative balance.

The problem is, the currency speculators, who don’t care who might suffer in a collapse as long as they get theirs, can see that the US dollar has nowhere to go but down. The US economy is dependent on Middle East oil and Chinese labour, on low interest rates and on citizen ignorance. Its national debt and its foreign balance of payments deficit are both unprecedented in the history of civilization, and both are soaring ever-higher by the month. If OPEC were to abandon the US dollar in favour of the more stable and solvent Euro, or if China were to want to refinance its huge receivable from the US in the new Asian currency, it’s game over for the dollar — the spring comes unsprung. There is then no limit to how far the US dollar could fall, and how fast, because there would no longer be anything propping it up. Panic selling would ensue. Just like in 1929.

So the currency speculators, like the child pointing out “the Emperor has no clothes”, are taking their money and running. That’s what’s slashed the value of the US dollar by 12% over the last year, and by over 1% in one day on Friday. Suppose you’re a supplier in the Middle East or China and your investments, denominated in US dollars, lost 12% of their value last year, and 1% on Friday alone, for no other reason than the weakness of that foreign currency. At what point do you say “enough is enough” and insist on being paid in a currency that has some fundamentals supporting its value?

I think that point is imminent. The panic reduction by the US Fed in interest rates to try to calm fears about the collapse of the housing market and the reckless lending practices that this collapse uncovered, will, I believe, be seen as the trigger — the acknowledgement that the bubble of the entire US economy is bursting. It was a desperation move, and investors around the world have seen right through it. It’s no accident that Greenspan’s book of economic ‘deathbed confessions’ has been rushed out now.

So let’s suppose the US dollar collapses, from its level of 87 a year ago to 77 today to, say, 67 by year-end and 57 by next Spring. What does that mean? First, it will mean that the US dollar will no longer be a monetary standard. The Euro will take that role, and perhaps the Asian Currency Unit (ACU) which has been proposed for years but which could take the place of the Asian currency ‘basket’ quickly if the Asian nations needed a hedge against the dollar’s collapse. That will continue the collapse, and ensure that the US will have to start buying in these stronger currencies. This will quickly produce (as has always been the case with currency collapses) runaway inflation in the US, so prices of many goods, and of energy, will be reposted upwards daily. Panic buying will ensue (as is always the case with hyperinflation), leading to empty store shelves and long lineups. That will be followed by an abrupt halt to consumer spending, since nothing will be affordable at the new prices.

When inflation soars, so must interest rates, so double-digit interest rates will quickly become commonplace for mortgages, consumer loans, corporate loans, and government debts. Foreclosures and corporate bankruptcies will soar, there will be runs on the banks, and the government will have to step in to bail out the banking system.

The problem is, the US treasury has no reserves to bail out anything. It will have to institute large tax increases, and slash spending (including war spending) and services to keep from falling into total bankruptcy. It may have to ask for IMF forgiveness on its debts, which may cause the Middle East and China to refuse to trade with it at all, except on a cash basis.

Where it gets complicated is that so many economies are so dependent on the US economy, that they will collapse as well. As usually happens in struggling non-democratic nations when their economies collapse, the result in the Middle East and China will likely be civil war, and substantial cessation of trade with other nations as war disrupts transportation and production.

Canada, whose governments have recklessly allowed our economy to become totally dependent on the US economy, will be sucked down into precisely the same cycle of crisis the US will be facing, probably within months. Europe will fare better, but not much better — so much of the economy is globalized now that to some extent we’re all co-dependent. We might be able to absorb the meltdown of the Argentine economy, but not the American.

With consumers unable to buy, and debtors unable to pay their debts, the stock markets will collapse, taking with them the lifetime savings and pensions of billions, and billions of jobs. The first few million families to default on their mortgages will suffer foreclosure, and lose everything. After that, the banks will realize that it makes sense to let delinquent homeowners stay in, secure and maintain their homes, since there will be no buyers to take their place anyway, so those who can afford to pay their mortgages a bit longer will probably be spared eviction. Just like in 1929.

There will be no winners in this. The people who will suffer least will be those who are self-sufficient (living in communities that are able to produce much of their own food, and whose members can look after themselves and each other) and who are debt-free. You can forget about your investments and pensions — there will be no safe haven. Even gold is worth only what people think it is worth, and if no one has money to spend on it, it will drop in value too. Those who depend on the automobile to get to work will, if they still have work, have to find another way to get there. Those who don’t have work will have to learn to make a living themselves. Very few of us have the skills to do so. Perhaps, like in Argentina, we will learn by occupying abandoned factories and figuring out how to run them as collectives.

I’m sure most readers think I am wildly exaggerating the dangers here. I used to believe that those who warned of a second Great Depression were simply fear-mongers, angry and jealous at being left out of the economic boom. The more I study the lessons of history, and the way economic systems work, the more worried and more pessimistic I become. We have been operating our economy at a level of reckless excess for most of the last half-century. We have come to believe that what we have known in our lives will continue forever, that it can continue forever. It’s that psychology of recklessness and groundless belief in unlimited growth and endless prosperity that is ratcheting the screws ever tighter, blowing the bubble ever larger, moving the dominoes closer to the tipping point, and blinding us to our economy’s terrible fragility and our lack of resilience. I hope I’m wrong. I don’t think Iam.

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5 Responses to The Collapse of the US Dollar: A Scenario

  1. Doug Alder says:

    A lot depends on who reigns in China. The military would love to see the US economy completely tank as China’s military is investing a lot in building a very powerful modern force. If the US economy tanks then the US military budgets will be slashed and that will mean its presence around the world wil be severely diminished. That’s the opportunity for China to start it’s imperial ambitions anew. As long as the proto-capitalists in Beijing hold sway they will do what they can, within reason, to prop up the US dollar because their own burgeoning manufacturing sector requires the US market, not to mention the heavy investment by US firms in China and also all the outsourcing. If the military rules once more you can probably expect a fast sell off of the 25% of US debt that China owns, done deliberately and at any cost, to sink the US economy for decades. It will be a military strike done through economics

  2. Carver says:

    Well, interesting thoughts and I’m still digesting them here, but one empirical fact I *have* been noticing with the dollar’s plunge, is the intensifying exodus of US-trained professionals to Eurozone nations, provided that they know (or are able to learn) the relevant language, usually German or French but occasionally Dutch, Italian, even something like Danish or Swedish.This is nothing new for IT– the double-whammy of the 2000 plunge of the Internet companies and then, the mass shift toward outsourcing and the H1B (which Hillary Clinton among others is stupidly trying to facilitate further, to her severe detriment), has been pushing American-educated techies to migrate especially to German high-tech centers such as Heidelberg, Dortmund or especially the low-cost of living tech centers in the German east such as Leipzig or Potsdam. Belgium and the Netherlands have obviously been big gainers, esp. in Antwerp and Rotterdam– the Dutch language (and of course German, which has some usage in sections of the Low Countries) has been enjoying a surprising boost in popularity. Some French mini-tech centers around Paris have also been gaining, as has the Milan corridor in Italy. (As a practical matter, anyone with Italian-American ancestry also has a relatively smooth path to working and living in Italy, while anyone with Germanic ancestry– not just German-Americans but also Swedish, British, Dutch, Balt Polish for example– also has easier entry into Germany.)Interestingly, almost nobody is going to the UK– with the bank runs we’ve been seeing in Britain recently, along with the shocking British debt levels which are multiples worse than even the USA, seems like England is already well on the way a 1929 redux. Australia and New Zealand are faring a little better, but not much– they too got themselves stupidly tangled in the US housing market bubble far too much for their own good, just like the banks in Britain seeing runs and closures, while their own currencies have also been stumbling against the Euro. Canada, as you point out, is too dangerously dependent on the US economy.So we’re seeing the same sort of thing that’s occurred in previous decades, i.e. labor and talent tends to flow toward the countries with the strongest currency which offers the highest value to professionals who have a choice of where to work– in this case, flowing from nations like the USA (or Canada/Australia) to Eurozone countries. At this point, seems to me that the only major factor blocking further such migrations is the language barrier, but even this is being surmounted as more American professionals take courses, get software or do whatever to master the relevant languages. German in particular, according to acquaintances who work in the bookselling business, has been taking off.As for the prospects for the global economy, well for one thing, I’m not sure about a mass dollar crash– there’s just too much at stake for too many countries for that, and besides, I suspect these very same currency traders might come swooping in to provide some kind of floor for a dollar fall, in anticipation of at least decent future profits for a mild dollar appreciation. Besides, the rest of the world really isn’t as dependent on us anymore– in particular can pick up much of the slack, while the oil-exporting countries in the Middle East can park their profits in the Eurozone. As the article points out, this also provides a cushion even for the USA.However, what is clear is that some substantial degree of geopolitical decline for the USA is inevitable, there’s absolutely no way we can ever pretend anymore to rule the world or dictate to other countries what’s best for them. It’s multipolar now, which means also that American culture, the English language, the US dollar of course and other things American are no longer the global center. Still important, but not central. And we’ll have to pay more attention to the needs of the Global South and also to the global environment– we no longer have fiat power. Which is probably a good thing for us, as much as everyone else, since it provides a kind of external cushion to prevent us from blundering into other costly fiascoes like Iraq. We’d also help ourselves by getting rid of our multi hundred-billion dollar useless defense systems, nuke warheads and other cases of pissing money right out the window, though I’m still not yet holding my breath for that.

  3. Mike says:

    For anybody paying attention, it seems quite clear that we are teetering on the brink of the abyss, for many of the reasons stated. The most obvious one to me is the extreme debtloads being carried by the general population as well as the U.S. government. When the bubble bursts, where is everyone going to get the money to pay these debts? They won’t, and will lose everything overnight. The dollar collapse is a symptom, not a driving force for economic collapse. It is just a matter of time. The US will of course use the situation to implement martial law, to further advance their “Project for a New American Century”. Don’t worry, even if the Democrats take power, nothing will change. They have done nothing since the last election to attempt to change the situation.The best thing to do is to prepare for the coming crisis as best we can. Denial will only make it more difficult to face the inevitable when it finally happens.

  4. The Chinese Yuan is pegged to the U.S. dollar. The Yuan is more naturally a stronger currency (especially since the Chinese hold so much U.S. debt). So this creates a bit of a ‘damper’ effect on the slide of the U.S. dollar. This helps all of us – but at the cost (as the Chinese know well) of greatly increasing China’s standing in world economic markets. As a matter of practicality, China will have to be admitted to the G8 (a move that will probably include India, for the sake of appearances). Should the Chinese unpeg the Yuan, it will be a sign of a complete break with U.S. economic policy, and will signal the precipitate slide you describe.Canada is in a good position to be relatively insulated from the worst of the American collapse. For one thing, while a part of the slide of the dollar is that country’s unrestrained borrowing, another more significant problem is its exhaustion of its own natural resources. American oil is depleted, its mines are exhausted, its forests are gone, its argiculture is running on chemicals, its fisheries are exhausted – even its people, who can no longer afford housing, education or health care – are staggering. Thus it needs to import almost all of these – hence the huge trade deficit – and as competition for these resources inscreases, the American ability to pay for them decreases.Canada continues to have strong natural resources; we have really only reached the limit in forestry and fisheries (and are developing silviculture and aquaculture to respond to this – I would be investing in Ontario lakes if I have billions of dollars). The environmentalists in Canada have been proven to be correct – it has made much more sense economically to preserve our resources than to rape them to sell to the Americans – particularly to Americans with increasingly bad credit.We can sell to China, India and Europe, and will continue to increase these exports. Moreover, as the cost of transportation increases, structural imbalances in manufacturing costs (specifically, lower wages elsewhere) will be mitigates. High fuel costs are good for Canadian manufacturers. We are also more resistant to interest rate shock than the U.S. (if the rate spikes sharply, the American economy will crumble overnight). It continues to make sense for Canada to pay down th debt and to maintain balanced budgets (and we should resist the urge to adopt U.S.-style credit market policies, such as tax cuts and military spending – these weaken our ability to cope, because they do not strengthen our capacity).

  5. Dave Pollard says:

    Interesting — thanks, Stephen. I think our great vulnerability is the extent (70%) to which we have allowed Canadian mid-to-large size organizations to be owned by Americans, which brings with it commensurate US ownership of our natural resources. As the environmental and economic and social costs of Alberta Tar Sands development are realized, we are going to realize that, thanks to that ownership and NAFTA, we will have no legal choice but to allow the US to devastate Alberta to slake their needs for cheap oil. Millions of Canadian jobs also depend on exports to the US, so when the US can no longer afford to pay for our goods, and cut back first on anything manufactured, we are going to suffer the same unemployment crisis they will have. So we’re not insulated much, I think.

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