The Demise Of The Dollar? Smith Warns "Don't Hold Your Breath"

Authored by Charles Hugh Smith via OfTwoMinds blog,

So let's look at currency flows, reserves and debt.

The demise of the U.S. dollar has been a staple of the financial media for decades. The latest buzzword making the rounds is de-dollarization, which describes the move away from USD in global payments.

De-dollarization is often equated with the demise of the dollar, but this reflects a fundamental misunderstanding of the currency markets.

Look, I get it: the U.S. dollar arouses emotions because it's widely seen as one of the more potent tools of U.S. hegemony. Lots of people are hoping for the demise of the dollar, for all sorts of reasons that have nothing to do with the actual flow of currencies or the role of currencies in the global economy and foreign exchange (FX) markets.

So there is a large built-in audience for any claim that the dollar is on its deathbed.

I understand the emotional appeal of this, but investors and traders can't afford to make decisions on the emotional appeal of superficial claims--not just in the FX markets, but in any markets.

So let's ground the discussion of the demise of the USD in some basic fundamentals. Now would be a good time to refill your beverage/drip-bag because we're going to cover some dynamics that require both emotional detachment and focus.

First, forget what currency we're talking about. If the USD raises your hackles, then substitute quatloos for USD.

There are three basic uses for currency:

1. International payments. This can be thought of as flow: if I buy a load of bat guano and the seller demands payment in quatloos, I convert my USD to quatloos--a process that is essentially real-time--render payment, and I'm done with the FX part of the transaction.

It doesn't matter what currency I start with or what currency I convert my payment into to satisfy the seller--I only hold that currency long enough to complete the transaction: a matter of seconds.

If sellers demand I use quatloos, pesos, rubles or RMB for those few moments, the only thing that matters is the availability of the currency and the exchange rate in those few moments.

2. Foreign reserves. Nation-states keep reserves for a variety of reasons, one being to support their own currency if imbalances occur that push their currency in unwanted directions.

The only nations that don't need to hold much in the way of currency reserves are those that issue a reserve currency--a so-called "hard currency" that is stable enough and issued in sufficient size to be worth holding in reserve.

3. Debt. Everybody loves to borrow money. We know this because global debt keeps rising at a phenomenal rate, in every sector: government (public), corporate and household (private sectors).(see chart below)

Every form of credit/debt is denominated in a currency. A Japanese bond is denominated in yen, for example. The bond is purchased with yen, the interest is paid in yen, and the coupon paid at maturity is in yen.

What gets tricky is debt denominated in some other currency. Let's say I take out a loan denominated in quatloos. The current exchange rates between USD and quatloos is 1 to 1: parity. So far so good. I convert 100 USD to 100 quatloos every month to make the principal and interest payment of 100 quatloos.

Then some sort of kerfuffle occurs in the FX markets, and suddenly it takes 2 USD to buy 1 quatloo. Oops: my loan payments just doubled. Where it once only cost 100 USD to service my loan denominated in quatloos, now it takes $200 to make my payment in quatloos. Ouch.

Notice the difference between payments, reserves and debt: payments/flows are transitory, reserves and debt are not. What happens in flows is transitory: supply and demand for currencies in this moment fluctuate, but flows are so enormous--trillions of units of currency every day--that flows don't affect the value or any currency much.

FX markets typically move in increments of 1/100 of a percentage point. So flows don't matter much. De-dollarization of flows is pretty much a non-issue.

What matters is demand for currencies that is enduring: reserves and debt. The same 100 quatloos can be used hundreds of times daily in payment flows; buyers and sellers only need the quatloos for a few seconds to complete the conversion and payment.

But those needing quatloos for reserves or to pay long-term debts need quatloos to hold. The 100 quatloos held in reserve essentially disappear from the available supply of quatloos.

Another source of confusion is trade flows. If the U.S. buys more stuff from China than China buys from the U.S., goods flow from China to the U.S. and U.S. dollars flow to China.

As China's trade surplus continues, the USD just keep piling up. What to do with all these billions of USD? One option is to buy U.S. Treasury bonds (debt denominated in dollars), as that is a vast, liquid market with plenty of demand and supply. Another is to buy some other USD-denominated assets, such as apartment buildings in Seattle.

This is the source of the petro-dollar trade. All the oil/gas that's imported into the U.S. is matched by a flow of USD to the oil-exporting nations, who then have to do something with the steadily increasing pile of USD.

Note what happens to countries using gold as their currency when they run large, sustained trade deficits. All their gold is soon transferred overseas to pay for their imports. So any nation using gold as a currency can't run trade deficits, lest their gold drain away.

Nations aspiring to issue a reserve currency have the opposite problem. They need enough fresh currency to inject into the global FX markets to supply those wanting to hold their currency in reserve.

This means any nation running structural trade surpluses will have difficulty issuing a reserve currency. Nations shipping goods and services overseas in surplus end up with a bunch of foreign currencies--whatever currencies their trading partners issue. This is opposite of the global markets need, i.e. a surplus (supply) of the reserve currency.

Any nation that wants to issue a reserve currency has to emit enough currency into the global economy to supply the demand for reserves. One way to get that currency into the global system is run trade deficits, as the world effectively trades its goods and services in exchange for the currency.

A reserve currency cannot be pegged; it must float freely on the global FX exchange. China's currency, the RMB, is informally pegged to the USD; it doesn't float freely according to supply and demand on global FX markets.

Nobody wants to hold a currency that can be devalued overnight by some central authority. The only security in the realm of currencies is the transparent FX market, which is large enough that it's difficult to manipulate for long.

(Global FX markets trade trillions of dollars, yen, RMB and euros daily.)

This is why China isn't keen on allowing its currency to float. Once you let your currency float, you lose control of its exchange rate/value. The value of every floating currency is set by supply and demand, period. No pegs, no "official" rate, just supply and demand.

If traders lose faith in your economy, your ability to service debt, etc., your currency crashes.

So let's look at currency flows, reserves and debt. In terms of currencies used for payments, the euro and USD are in rough parity. Note the tiny slice of payments made in RMB/yuan. This suggests 1) low demand for RMB and/or 2) limited supply of RMB in FX markets.

The USD is still the dominant reserve currency, despite decades of diversification. Global reserves (allocated and unallocated) are over $12 trillion. Note that China's RMB doesn't even show up in allocated reserves--it's a non-player because it's pegged to the USD. Why hold RMB when the peg can be changed at will? It's lower risk to just hold USD.

While total global debt denominated in USD is about $50 trillion, the majority of this is domestic, i.e. within the U.S. economy. $11 trillion has been issued to non-banks outside the U.S., including developed and emerging market debt:

According to the BIS, if we include off-balance sheet debt instruments, this external debt is more like $22 trillion. FX swaps and forwards: missing global debt?

Every day, trillions of dollars are borrowed and lent in various currencies. Many deals take place in the cash market, through loans and securities. But foreign exchange (FX) derivatives, mainly FX swaps, currency swaps and the closely related forwards, also create debt-like obligations. For the US dollar alone, contracts worth tens of trillions of dollars stand open and trillions change hands daily. And yet one cannot find these amounts on balance sheets. This debt is, in effect, missing.

The debt remains obscured from view. Accounting conventions leave it mostly off-balance sheet, as a derivative, even though it is in effect a secured loan with principal to be repaid in full at maturity. Only footnotes to the accounts report it.

Focusing on the dominant dollar segment, we estimate that non-bank borrowers outside the United States have very large off-balance sheet dollar obligations in FX forwards and currency swaps. They are of a size similar to, and probably exceeding, the $10.7 trillion of on-balance sheet debt.

So let's wrap this up. To understand any of this, we have to start with Triffin's Paradox, a topic I've addressed numerous times here. The idea is straightforward: every currency serves two different audiences, the domestic economy and the FX/global economy. The needs and priorities of each are worlds apart, so no currency can meet the conflicting demands of domestic and global users.

Understanding the "Exorbitant Privilege" of the U.S. Dollar (November 19, 2012)


So if a nation refuses to float its currency for domestic reasons, it can't issue a reserve currency. Period.

If a nation runs trade surpluses, it has few means to emit enough currency into the FX market to fulfill all three needs: payment, reserves and debt.

As for replacing the USD with a currency convertible to gold: first, the issuer would need to emit trillions for the use of its domestic economy and global trade (let's say $7 trillion as an estimate). Then it would need to issue roughly $6 trillion for reserves held by other nations, and then another $11 trillion (or maybe $22 trillion) for those who wish to replace their USD-denominated debt with debt denominated in the new gold-backed currency.


So that's at least $24 trillion required to replace the USD in global markets, roughly three times the current value of all the gold in existence. Given the difficulty in acquiring more than a small percentage of available gold to back the new currency, this seems like a bridge too far, even if gold went to $10,000 per ounce.

Personally, I would like to see a free-floating completely convertible-to-gold currency. Such a currency need not be issued by a nation-state; a private gold fund could issue such a currency. Such a currency would fill a strong demand for a truly "hard" currency. The point here is that such a currency would have difficulty becoming a reserve currency and replacing the USD in the global credit market.

Issuing a reserve currency makes heavy demands on the issuing nation. Many observers feel the benefits are outweighed by the costs. Be that as it may, the problem of replacing the USD in all its roles is that no other issuer has a large enough economy and is willing to shoulder the risks and burdens of issuing a free-floating currency in sufficient size to meet global demands.

Of related interest:

How Dangerous Is Emerging Markets Dollar Debt?

$10.5 trillion in dollar-denominated debt

The Fed's Global Dollar Problem Borrowers around the world have gone on a dollar binge. This makes them vulnerable when interest rates rise.

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ejmoosa MANvsMACHINE Fri, 09/22/2017 - 09:49 Permalink

The dollar counts on everyone having their inventory of $$$ to make transactions.  That's what has supported the dollar over the decades.  It's why pallents of dollars have been flown at midnight to who knows where.But two parties will be able to conclude their transactions in milliseconds, moving into and then out of the dollar, without holding any dollars.  So who is going to be left holding the inventory of dollars then?Germans never thought their currency was headed to zero.Neither did the Confederacy.The list is endless.The dollar will be no exception. 

In reply to by MANvsMACHINE

RU4Au Yukon Cornholius Fri, 09/22/2017 - 12:39 Permalink

Ok, so the dollars come home. He talks about the dollars only being used for minutes to do a specific transaction and having no effect on the value of the currency. He talks about countries holding reserves of the reserve currency. The fact there is no other reserve currency does not seem to be an adequate explanation as to why the dollar can't disappear.If the dollar continues to inflate from our chronic deficits and domestic spending then those instant transactions into and out of other currencies are irrelevant still, but those that hold reserves will start to look for an alternative as a reserve.... something .... anything, if the reserve value of their reserves continues to collapse. The dollars being held as reserve will be spent and come home. They don't just disappear. They go onto a ballance sheet somewhere and the number of dollars moving in the system is increased relative to goods available.   This is more inflation.  This then entices the other reserve holders to unload and the cycle repeats, leading to domestic hyperinflation. How is it that the dollar cannot self destruct?

In reply to by Yukon Cornholius

MoreFreedom Yukon Cornholius Fri, 09/22/2017 - 15:06 Permalink

"Why hold RMB when the peg can be changed at will? It's lower risk to just hold USD."This is why RMB isn't going to replace the dollar anytime until the RMB exchange rate is allowed to float.  And it's also partly why the US dollar is still just about king: the other alternatives are worse.  Typically what happens is banks go bankrupt and people can't withdraw thier funds.  But will the US government allow that to happen for all the banks at once?  The Feds will then start the printing presses and inflation will begin in earnest, until your dollar holdings are inflation taxed sufficiently to bail out the banks and the governments. In the meantime, expect your real property to be taxed higher to bail out the local governments.  

In reply to by Yukon Cornholius

mkkby JRobby Fri, 09/22/2017 - 19:32 Permalink

Big surprise -- none of the hedge tards read and understood the article so they just repeat the gold/hyperinflation bullshit they heard from some doom sayer.

The dollar is going nowhere for the next 30-50 years. China, japan, the UK and most EU countries will "go greece" first. That is your 18 month warning. You'll have plenty of time to convert your assets before the hammer falls.

In reply to by JRobby

dark fiber Fri, 09/22/2017 - 09:06 Permalink

The prevalence of the dollar in global trade is largely due to the MIC.  It will take a major US military defeat for the dollar to truly collapse, because have no doubt about it, the US will go all out nuclear if the global status of the dollar is materially threatened.  That however does not mean that the dollar will not lose more and more of its value.  It has been doing so since 1913.  The new element here is that there are countries that are now willing to match the US ICBM for ICBM to get rid of the dollar, because frankly, they are sick and tired of US psychopathy.  NK is just a proxy of those countries. 

Grandad Grumps Fri, 09/22/2017 - 09:05 Permalink

The moneetary system needs to be refreshed. With the old paper money systems it would take 10 to 15 years, but with some hybrid of the SDR and a global crypto currency, it can probably be done in under 5 years.

The British pound is still around. It is just not the basis for the global monetary system. Gold is still around .. ditto.

Davidduke2000 Fri, 09/22/2017 - 09:06 Permalink

Do not count on the debt of getting repaid, it does not matter if it in usd , the us banks are going to take $billions in losses possibly trillions. the us dollar will go down mostly because of a run on the gold and silver. 

Haitian Snackout Davidduke2000 Fri, 09/22/2017 - 11:15 Permalink

Quite correct, in fact, almost of the opinions are correct. But it is a long way from here to there. We all have seen how they scalp the shorts in the little casino on wall street. Hard productive, and sometimes less productive assets are the best choice IMHO. If I lose my 20% Dollah allocation it's not the end of the world. It will be converted into land most likely at some point. But many leveraged entities and people will scramble to pay for those hard assets they bought on credit. And the other they wasted on hookers etc. Yes, in the long run, all fiat is trash. But the game isn't over yet. Don't fold the hand until all the cards have been played is all I'm sayin.

In reply to by Davidduke2000

Winston Churchill Fri, 09/22/2017 - 09:07 Permalink

Simplistic article.All hegemons start with sound  money backed by violence.When only violence remains they go into decline.The other symptoms,runaway corruption both, economic and moral,come from the immorality of unsound money probaly.Not vice versa as commonly believed. 

GodHelpAmerica Fri, 09/22/2017 - 09:08 Permalink

This guy presumes the financial system will be maintained in its current form...

The dollar may not be replaced per se; the entire system will be replaced. So the greatest beneficiary of the current system (the US) is likely to be knocked down a few pegs...

DulciusExMan Fri, 09/22/2017 - 09:08 Permalink

Yep, which is why I always look at all of the talking heads who yell "the sky is falling" from all of the different sites......but at the same time they sell PM's.  Kind of odd.  I think this system we have will keep chugging along......until TPTB say it's over.  You and me and the rest of the "not in the club" crowd won't know anything until the musc stops.  Accept it and move on.

Ink Pusher Fri, 09/22/2017 - 09:14 Permalink

Take all the petro-currencies and stuff 'em in a tailings exit pipe.Not as long a game as one might be inclined to think.Bullion backed currencies are making a steady return and will eventually dwarf the debt heavy petro-fiasco-fiats.

who cares Fri, 09/22/2017 - 09:20 Permalink

The dollar has no other way to go but down. China will have their currency used more and more for international exchange and that will drastically cut the USA capability of printing fiat dollars without greately devalueing it.

66Mustanggirl Fri, 09/22/2017 - 09:20 Permalink do they even peddle this bullshit with a straight face anymore???
A little story from the REAL world to illustrate a point.

In 1984, my husband and I were fresh-faced newlyweds of 2 years. He worked in a paint store. I waited tables. If we had a combined income of 25k I would be surprised. Yet, we were able to purchase our first home (with some help from his parents); a cute little bungalow, for $39,000 at 10.9% interest. We purchased a brand-spankin'-new Chevy Cavalier to drive. We took small vacations. We ate out. My husband hunted and/or fished every single weekend for most of the year. We were, by no means, without financial struggle but we enjoyed life!

Oh.....and the Dow started the year at 1258.64 and ended at 1211.57

Today? We have a combined income of over 80k. We refuse to use credit cards (been down THAT disastrous path in our younger years) so the only debt we carry is a $123,000 mortgage. We both drive cars that are 16 and 15 years old, respectively. We rarely eat out. Don't smoke, gamble, shop, or do drugs. My husband's big luxury is a case of Budweiser every two weeks and a Wednesday golf date with his buddies. FRUGAL is our mantra. Where does our "disposable" income go? Helping our "kids" who graduated college with a ruinous amount of college debt. (They are all professionals; 2 nurses and another who is in upper management for our State Park system). We have one more who is graduating high school this year and wants to be a Veterinarian. (Ha! Good luck with THAT!). My oldest son and his wife saved for 7 years to buy their first home, with our help, for $235,000. They make close to six figures but are struggling. They also refuse to indulge in the credit card mania, so frugality is also their mantra.

Oh! But....blare the trumpets.....the almighty Dow is at 22,419.57!!!!!!

Any of you financial whizzes out there notice a slight, shall we say, aberration in the numbers???

Tick....tock.....that's the sound of this frickin' economic FAIRYTALE created by Wall Street and the FED, where flying rainbow unicorns roam free among cotton candy clouds, and its rapidly approaching date with Karma. And in case you haven't noticed, she's being a royal BITCH this year. *KA-BOOM!! * is the only warning anyone will get when this freak show comes crashing down. And make no mistake.....that day is coming. Fast.

RafterManFMJ 66Mustanggirl Fri, 09/22/2017 - 10:40 Permalink

FOFOA breaks the world into exactly 2 fueding camps:

The Savers and the Borrowers

What you’ve done is lived a natural and good life, a biblical life of thrift and self-denial. A saver lifestyle. You’re the ant, so to speak.

Sadly, the .gov and it’s various hanger-on are the locusts, HUGE borrowers, and - unlike you, they set policy.

Sure it’s immoral to spend and blow your people’s money and leverage their children into chains but - that’s the way it is.

...and when the .gov locusts, the ponzi public pensions, the tick welfare classes...when their wells run dry they will come for you and your kids and whatever you’ve managed to save. Simply because you can’t rob people that have nothing, and you DO have something, and to eat the crops of others is their very nature.

You’ve lived righteously, and in the USSA you’re going to pay pay pay for doing so.

In reply to by 66Mustanggirl