The U.S. dollar is not fiat paper currency.
According to the U.S. Bureau of Engraving and Printing, our paper currency is made up of 75% cotton and 25% linen.
Another fun fact: “In God We Trust” must appear on U.S. currency. As much as I like that, it’s probably less about our faith in our Creator and more about faith in general. Because if we don’t believe in the stated value of our money, then it might as well be fancy toilet paper.
And it’s not just us Americans who need that faith …
The U.S. dollar is far and away the world’s primary reserve currency. And yet, many have trouble believing in it.
A prominent commentator and author — Barry Eichengreen — worries that the U.S. dollar’s reserve currency dominance is in jeopardy.
Mr. Eichengreen is a smart man. He surely knows a great deal more than I do about the International Monetary System. And he has a very logical explanation for why the dollar’s reserve currency status is vulnerable. Namely that U.S. diplomacy is deteriorating.
Much of his argument rests on a statistic that countries with nuclear weapons hold 30% fewer U.S. dollars in reserve, on average, than those with diplomatic ties to the United States’ military might.
But what he points to as evidence of fraying diplomacy is, to me, insignificant at this point.
Concessions to North Korea that leave a void? For China to fill? And, as an eventual result, if Japan and South Korea were to pare back the 80% of their reserves that are U.S. dollars, what then?
As Eichengreen himself writes,
“Central banks still hold U.S. Treasury bonds because the market for them is the single most liquid financial market in the world.”
For that reason alone, China’s currency cannot yet serve in a reserve currency capacity. Not at anywhere near the level the U.S. dollar does. And this doesn’t even address the Impossible Trinity — a sort of Münchhausen trilemma — that China must wrestle with if it truly seeks to unseat the U.S. dollar with its renminbi.
This is why Eichengreen is focused on diplomacy.
He feels China’s military can fill gaps more easily than China’s capital markets can.
But, for better or for worse, a breakdown in U.S. military alliances is even less likely to trigger a flight out of U.S. dollar reserves and into Chinese renminbi.
Because it assumes a breakdown of U.S. military alliances.
Maybe alliances will break down “on paper.” But it’s unlikely that America’s global military influence will break down anytime soon.
America’s power interests do everything in their power to maintain global power because it’s big business.
Roughly 10% of U.S. manufacturing — $2.2 trillion — goes into the production of weapons primarily for the Department of Defense. The $611 billion the U.S. spends is more than the next eight largest military budgets combined. And President Trump is ready to add about 10% more spending to the total next year.
The world may not like an orange quiff. But who doesn’t want the world’s largest military and “most liquid financial market” doing their bidding?
Is this to say any alternate reserve currency scenarios laid out by Mr. Eichengreen, or anyone else for that matter, can never or will never come to pass?
No, not at all.
If, for example, global petroleum trade begins being priced in something besides just U.S. dollars, then it might necessitate a shift in global reserve currency proportions.
But barring a development like that, the reserve currency status quo is considerably more plausible for now.
I see no reason to be concerned about the U.S. dollar’s status. And I’m sticking with the normal market indicators I use to forecast the value of the U.S. dollar and foreign currencies. Those indicators have served, and continue to serve, me well.
If you still fear the imminent demise of the dollar, have a little faith.
P.S. I hope you were able to attend The Edelson Institute’s Supercycle Investing Summit this week. We just completed the third and final session about 90 minutes ago. If you missed this all-important three-part series or you want to review it again, click here for the recordings.