If you think Obamacare is bad, consider reserve currencies

[dropcap]T[/dropcap]he last week or two have brought with them a cascade of negative news about Obamacare. Almost every day I read of a friend or relative whose premiums are skyrocketing, policies are being cancelled, do not qualify for subsidies, and the like. So far, the sign-up process has had its share of troubles. Even President Obama has not been impressed.

What if Obamacare is not the worst thing happening? What if something was happening with the potential to dwarf Obamacare?

There is. And, it could.

Prior to the last election there was considerable talk from one candidate about problems with a policy called “quantitative easing,” sometimes called QE. It is a scheme by the United States central bank to create as much money as it deems necessary to keep our economy going in the short term. In the past few years our central bank, the Federal Reserve, has churned out rounds of quantitative easing frequently enough to use the names QE 1, 2, 3 and 4.

Quaint.

Also prior to the last election red flags were raised about the U.S. dollar and its unique place in the world economy. The U.S. dollar is the world’s reserve currency.

A reserve currency (or anchor currency) is a currency that is held in significant quantities by governments and institutions as part of their foreign exchange reserves, and that is commonly used in international transactions. Persons who live in a country that issues a reserve currency can purchase imports and borrow across borders more cheaply than persons in other nations because they need not exchange their currency to do so…As of 2013 the United States dollar is the world’s reserve currency, and the world’s need for dollars has allowed the United States government as well as US Americans to borrow at lower costs, granting them an advantage in excess of $100 billion per year.

Being the owner of the world’s reserve currency is a benefit to every American even when we are ignorant of it. A recent NBC story, “Passing the buck,” concurs:

Some 80 percent of foreign exchange transactions are conducted with dollars, and American money accounts for more than 60 percent of overseas reserves, the investments that foreign governments and banks sock away.

Oil is bought and sold around the world in dollars. Foreign currencies are measured against them. And when there’s a crisis, even one wrapped in red, white and blue, world investors seeking stability buy American green.

That means the U.S. government can borrow money cheaply, and it means Americans pay less for their homes and cars.

Now, what if we were not longer the holder of the world’s reserve currency? Rather than the dollar, what if the reserve currency were the British pound? Or, possibly, the Chinese yuan?

100_dollar_bill

An article in The American Spectator this week posits such a scenario. Becoming the reserve currency provider seems to be exactly the play China is trying to make. Writes William Tucker:

Well, the Chinese here are striking at our Achilles’ heel — the role of the dollar as the world’s reserve currency. Let’s go back to Ben Bernanke’s “qualitative easing” and the argument that the national debt doesn’t matter because “we owe it to ourselves.” The fact is we don’t owe it to ourselves anymore. Fully one-third of our debt is owned by foreigners. China and Japan are the largest stakeholders, each owning 7 percent. If we just owed this money to American investors, we could just stiff them the way the government stiffed bondholders at GM and Chrysler — or the way savers are currently being stiffed by the Fed’s zero interest rates. There is nothing anyone could do except move their money abroad. (This is apparently already happening, since the U.S. is experiencing a negative investment capital outflow.)

But the real danger lies in the dollar’s role as the world’s reserve currency. This is the legacy of our hugely productive economy during and after World War II when we played the role of world leadership. “At the Bretton Woods Conference of 1944, the major western powers turned over responsibility for maintaining a stable world currency to the United States,” says Lewis Lehrman, the long-time advocate of the gold standard. “Unfortunately, it’s a responsibility that we haven’t fulfilled.”

In other words, the Fed is already playing with fire by inflating our dollars, but is reticent to treat China and Japan (not to mention Sovereign Debt funds) like it would treat us were we the only debt holders.

Further,

what “quantitative easing” really means is that we are dumping out domestic profligacy on the rest of the world. We go on running up debt and printing dollars and the rest of the world is forced to take them because, based on its former stability, the dollar still serves as the international means of exchange in 60 percent of world trade. There are now more $100 bills circulating abroad than at home. It’s the kind of situation that will go on until someone successfully challenges the dollar’s role as the world currency.

[…]

As holders of $1.1 trillion in American debt, the Chinese are the principal victims of our inflationary policies. So far, however, there’s not much they can do about it. In 2009, as the American economy was collapsing, Chinese Prime Minister Wen Jiabao warned “We have lent a huge mount of money to the US. Of course, we are concerned about the safety of our assets. To be honest, I am definitely a little worried.”

Of course, China is not sitting still to see if our Congress can figure out how to run the country and the Fed continues to threaten the economy. No, China is going for the jugular: the currency reserves. Tucker continues:

What the Chinese have been doing, however, is quietly building a financial infrastructure that would allow them and the rest of the world to free themselves from dependency on the dollar. They have suggested substituting promissory notes from the International Monetary Fund in world trade and struck deals with Russia and the OPEC nations to trade outside the dollar. They have established direct exchange of the yuan with Hong Kong, Taiwan and Singapore. Last spring Australia agreed to make its currencies directly convertible with the yuan and has since shifted 5 percent of its reserve holdings into yuan instead of dollars. The Chinese are negotiating a similar arrangement with New Zealand. And now they will be moving into London and the European market as well.

All this may seem very distant but it represents an historical shift that could come about very quickly. “We hear arguments that China has a long was to go before they could become a major international reserve currency but let’s not kid ourselves. The process is already underway and a lot further down the road than most people think,” says Stuart Oakley, head of foreign exchange trading at Nomura, a global investment bank in Singapore. Michael Pento, president of Pento Portfolio Strategies, who writes frequently for Huffington Post, adds: “The No. 1 security issue we have as a nation is the preservation of the U.S. dollar as the world’s reserve currency. It’s a thousand times more important than a nuclear bomb being tested by North Korea. Yet we are doing everything to abuse that status.”

There are people who believe such a drastic shift will not happen, or will not happen soon (see Yahoo News on the same subject). But if it does happen the results to our economy could be catastrophic. In the NBC story above, Barry Eichengreen, author of “Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System,”

estimates that toppling the dollar from its throne could cost the U.S. 2 percent of its economic output.

There would be a run on other currencies, and “there won’t be enough Swiss francs to go around,” Eichengreen said.

William Tucker suggests a run on the dollar internationally could costs Americans up to 30% of our personal net worth.

In late 2013 only God knows whether the dollar will remain the world’s reserve currency, but this is certain: if there is an international run on the dollar, the cost of Obamacare will be an ice cream cone in comparison.

Marty Duren

Just a guy writing some things.

  • Well written and timely article. I saw yesterday that at the current rate of spending, the US government debt will reach $22 trillion by Feb 2014. “The country is in the best of hands.”

  • Wade Burleson

    Well written, Marty. It’s coming. I think a 30% loss of individual assets (retirement accounts, savings, etc…) is a tad conservative. I see 50% or more. By the way, though I’ve written on this several times and see the economic collapse in America imminent, I happen to believe it is the best possible scenario for eternal reasons. Until we seek His Kingdom first, the Spirit cannot quench our thirst. The Spirit is never limited in power; we are limited in desire. We evangelicals in America are wealthy (look at our fabulous buildings and homes), we are egotistical (everything is about ‘so-and-so’s’ ministry), and we are comfortable, in need of nothing — including the Holy Spirit. Until we realize how wretched, pitiful, poor, blind and naked we are, we will never seek “the Kingdom that cannot be shaken” (Hebrews 12:28).

  • Bob Allen

    Thanks for tackling a subject that too many Americans do not grasp for its significance. I think it is much more likely that the world will crown something like the IMF’s SDRs as the next official reserve currency, rather than the yuan (there is still too much opacity in China’s financial dealings, though they’re significantly headed in the right direction), but the impact of any shift is the same.

    Not only will it have an immediately impact on saved wealth, but the price we pay for anything from overseas (food, fuel, goods) will absolutely skyrocket as the dollar devalues (simple supply and demand–a huge supply of dollars with less demand for them, and the value plummets).

    Final point: When the dollar is dethroned, America loses Superpower status. And with the way we’ve treated everyone in the world through our NSA escapades, it might be hard to find any friends left who feel any twinge of sorrow over our fall.

    Good thing our Treasure is not on this earth, but the pain will still be very real.

    Bob

  • With great risk, looks like to many poo pooed Marx’s critique. Had we really been “for all” in our Christian Country, maybe we would have set about to establish policies and structures more commensurate with the value we would have given to others, the “for all.”

    But wait, that guts the narrative used today to “call us back.” To “what” are we calling, we should ask.

    Good post Marty.

    I read a piece or two by Wade on the subject. There is enough nuance to go around in these pieces that make them all of great value.

    Thanks.

  • selahV

    sadly, the vast majority of Americans are like the proverbial ostrich. and as long as “free” phones, healthcare, and cheese is being distributed, the mice will continue following the pied piper down the alley of no return. no one wants to hear or even take time to read these scenarios, Marty. great post. selahV

  • Keith

    The Chinese are also investing a lot in hard US assets (real estate, farm, food processing, etc.). I am a engineering consultant and have been asked by a large international firm to be on the look out for those types of investment opportunities for them.

    Good post. I hope folks will look into this and realize the pain and suffering that is coming. I doubt the folks in DC will be able to stomach a cure so the rest of us will suffer. Perhaps a good follow-up post would be to describe some things that common folks can do to protect themselves.

    • martyduren

      Keith-

      A recent news report covered China buying or leasing 5% of the available farmland in Ukraine. It leaves the door open for up to 9% of the arable land. They definitely have a long term plan.

      http://articles.timesofindia.indiatimes.com/2013-09-26/china/42425827_1_ukraine-dnipropetrovsk-chinese-company

      • Keith

        Interesting article. At a minimum they are looking to invest in things besides US dollars, really pretty smart. It would be what I would do if I had their pile of cash.
        The imported food angle is also interesting. Ties in with some of the modernization I am seeing in agricultural practices in conjunction with their processing companies. The companies are becoming more vertically integrated and looking for ways to expand into NW China where development is welcome and there is a lot of market potential in Russia and the neighboring “Stans.”
        Certainly a good way to “flex muscle.” Remember the “Cold War.” We didn’t beat the USSR straight up with military might, we bankrupted them. Hmm…
        Another interesting angle on the QE fiasco is how it is moving wealth from middle/upper middle America to wealthy America and destroys fixed income folks and savers.