Saturday, April 09, 2011

Dollar: Faltering Foundation of US Economic Strength

I wrote this article back in Jan of 2008 in an attempt to shed light on the past history and likely future of the US Dollar as the World's reserve... Bottom line, dollar hegemony will eventually end and when this happens our standard of living will fall precipitously.

Since the end of World War II, the central foundation of US Economic Strength has rested on the US Dollar. Many of our strategic plans, geopolitical strategies, past and future wars--the entire global chess board if you will, has been played out by trying to maintain our undisputed economic power, based primarily through ownership of the World’s Reserve Currency.


Throughout the history of the world, there have always been strong currencies, usually held by the economic powerhouses of the day. Theses currencies were primarily called Reserve Currencies. The Pound Sterling was the primary reserve currency for much of the world in the 18th and 19th centuries. But perpetual account and fiscal deficits, financed by cheap credit and unsustainable monetary and fiscal policies used to finance wars and colonial ambitions eventually led to the pound sinking (sound familiar?).

Post World-War II, the US dollar took over the sterling’s dominant position and became the world’s newest reserve currency. The Bretton Woods Accord, the first major economic transformation toward the end of World War II, established the International Monetary Fund (IMF) and a way to value the various currencies of the world relative to each other. All foreign currencies would trade in relationship to the US Dollar and only the US dollar (as the reserve currency) would be tied to a gold standard (meaning the value of dollars circulating must be backed by gold reserves).

The gold standard caused major problems in the 1960’s when France (under the London Gold Pool) called America’s bluff and demanded gold for payment of debt, rather than US dollars (they understood that we were printing more money, to finance the Vietnam conflict and fund new social programs, than we had available in gold reserves).

Due to the rapid loss of US gold reserves, President Nixon had no choice but to abolish the Bretton Woods accord in August of 1971 and he took the US dollar off the gold standard (it was $35 per ounce then; today it is ~ $900).

This Nixon shock of August 1971 caused a swift devaluation of the US dollar (gold doubled in price by 1972) and numerous efforts followed (by U.S. leadership) to develop a new system of international monetary management. They felt they must find another way, as currencies around the world were in turmoil and were now floating among one another…

The year 1974 provided the much needed answer. In June of 1974, Secretary of State Henry Kissinger established the US-Saudi Arabian Joint Commission on Economic Cooperation. One of the major components of this commission stated that OPEC would officially agree to sell its oil only for dollars—meaning any country purchasing oil from OPEC had to pay in U.S. dollars. This agreement enormously increased the demand for the floating dollar, as oil importing countries now had to earn or borrow dollars to pay for their oil.

OPEC oil countries were soon overflowing with petrodollars and most of them ended up recycled through accounts in London and New York banks.

Bottom Line: this 1974 act reestablished the dollar as the global monetary instrument and oil now replaced gold as basis for a strong dollar. Countries competed for dollars and they accumulated huge dollar reserves to sustain their own currencies.

Please allow me to shift gears a bit—we’ll get back to the dollar in a moment:
Post WWII, the US was the world’s manufacturing powerhouse, as our continent was unscathed by the ravages of war and the military industrial machine was running at maximum efficiency.

That however has changed over time, as thousands of corporations succumbed to the pressures of improving their bottom lines. Entire sectors were outsourced: U.S. Manufacturing, Steel, Technical services, Administrative call centers, Research & Technology and numerous others are now gone. Heck, you can’t even find a pair of Levis (the American Trademark) made in the good ole USA anymore.

Why did this happen? It’s all related to profits… A U.S. company can pay a worker overseas $1-2 bucks an hour to do the same job requiring $15-30 hour in the US... Either they outsource or they end up like the rest of our troubled U.S. home bound corporations (below).

Many of the home-bound US companies still trying to compete in the Global marketplace are reeling from high labor costs, pension plans, union benefits, health care costs and the like. Delphi, General Motors and Ford are prime examples of the growing trend of companies feeling the pressures. I expect to see more US corporate and worker problems in the future…

Outsourcing however did have its benefits. For many years we Americans were able to export inflation through the import of cheap manufactured goods and recycled dollars. Foreign manufacturing allowed Americans to purchase many things that otherwise they could have never afforded had they been made in the USA (e.g. $20 Jeans, $29 DVD players, $50 Microwave ovens, $60 cell phones, $100 TV’s; $200 computers, the list goes on and on). Our standard of living rose, but we eventually became a service-based economy dependant upon 1) selling each other foreign made goods and 2) foreigners recycling their excess dollars back to the US.

This foreign recycling of dollars provided Americans with low interest rates, plenty of available credit and it allowed us to live far beyond our means through cheap debt.

On the negative side, foreign governments built up huge dollar denominated holdings that they could use to secure long-term energy agreements, purchase Global assets/corporations, etc and these massive holdings realistically (it will never be admitted) tied our hands geo-politically, as foreign governments could now threaten to dump dollars into the world market as retribution for disliked policy.

Back to the dollar:

Once removed from the gold standard in 1971, the US dollar became a fiat currency (tied to nothing tangible and it was backed only by the word of the US government). The Fed Reserve Banking System could now print money at will -- and they did. Take a look at the chart below and the growth in M3 money supply since 1971. This chart ends in 2006, but (in case your wondering) today’s figure is ~ $12.5 Trillion.

As the world’s reserve currency, the US has been able to, year after year, import goods from the rest of the world (for consumption) and pay for it with dollars that were created from nothing. These dollars are then used by foreign central banks to purchase US assets (corporations, land, properties, etc) or debt instruments from the Fed, or they amass these excess dollars to keep inflation tame within their borders, as many have their own currencies pegged to the exchange rate of the US Dollar.

It is currently estimated that foreign governments (OPEC Nations, China, Japan, India, Great Britain, Korea, Russia, etc) have amassed ~ $4 Trillion of US dollar holdings. China alone is sitting on ~ $1 Trillion (Pretty scary stuff).

Over the last several years, foreign Central banks have started to become leery with the huge debt levels, massive trade deficits and unsustainable fiscal policy of the US and they are quietly working to diversify their dollar holdings.

Additionally, for decades now, many foreign countries have pegged their currencies to the US Dollar, but recent inflation increases, internal to their domestic economies, has become far too severe for them to handle (with the dollar peg, they have to print money as fast as we do, and it is stoking domestic inflation), therefore several countries have started a new trend of depegging. Recently, Vietnam, Qatar and Kuwait have all depegged while a host of others (Russia, and other OPEC Nations) are questioning whether or not they should do the same… When this currency de-peg happens on a larger scale (not if, but when) inflation within our borders will SCREAM. Why? Well, as they de-link from the dollar, their currencies become stronger causing our import costs to increase commensurately (e.g. Oil, consumer goods, etc)

Lastly, governments such as IRAN no longer want to accept dollars for oil. This was also the case with IRAQ back in Saddam Hussein’s day, but we all know what happened there. Anyway, the point is: There is wide-scale pressure afloat to price oil in currencies other than the depreciating US Dollar. If that happens on a larger scale, the artificial foundation for the World’s Reserve currency will be removed and all hell could break loose.

Bernanke: Rather than try to shore up foreign confidence in the dollar, Helicopter Ben Bernanke has made matters worse by officially sacrificing the dollar to save our faltering, sub-prime like, US banking/financial systems… By lowering rates at a time when the dollar is already at its weakest point in history, there is no other explanation to his actions.

Bottom line: Demand for the World’s Reserve Currency (dollar) has been kept artificially high for many years through oil pricing agreements and US inflation was held in check by importing cheaper goods. These were both net benefits for the US in times past, but are quickly moving towards being detriments.


The US was once an economic powerhouse who earned the right to own/maintain the World’s Reserve currency, but we’ve squandered this luxury through massive debt loads, poor foreign policy decisions, excessive monetary printing, outsourcing our industrial base, making too many future promises and by living way beyond our means.

Foreign Governments are now growing tired of subsidizing our opulent lifestyles, and the recent fact that we put the world financial system in peril by offloading our toxic securitized garbage was (I believe) one of the final straws to break the dollar’s back. In another ~ 10 years, dollar hegemony will probably be a thing of the past. Our central foundation of US Economic Strength (dollar) is faltering and there is little we can do about it.

With that said, I think the Fed and our government officials are already aware of this and without any viable solutions to our current financial problems (baring raising interest rates and initiating a massive depression) they have made the best choice they can (cut rates and inflate).

I believe it has now become a matter of (unwritten) policy to try to hyper-inflate our financial system out of its current and future insolvency crisis. In their attempt to inflate, the world will experience significant dollar devaluations which will (over time) allow the United States to 1) eliminate much of its foreign debt and 2) pay for future (currently un-funded) obligations through devalued payouts.

As our standard of living drops more in-line with the rest of the world due to loss of purchasing power and a massive economic slowdown, it will (over time) become much cheaper to employ American workers again and this will slowly bring jobs back into our borders. Eventually, 20-30 years from now, our country will become competitive in the world again and we will do more than just sell each other cheaply made foreign goods--we will actually manufacture them again. BUT, we will (most likely) no longer own the World's Reserve Currency nor will we be the World's main economic power.

Ultimately, I believe massive currency devaluation and a much lower US standard of living is our country's only way out of this financial predicament...

The only wildcard I can think of is Oil. How in the world do we survive without cheap oil?
Guess we'll need to work out some new strategic plans and geopolitical strategies -- and I'll bet they lead to:



Anonymous said...

Very informative post. I imagine there are very few who really understand how the falling dollar could affect its status as the world's reserve currency.

Anonymous said...

Hi Randy! Guess we'll need to work out some new strategic plans and geopolitical strategies -- and I'll bet they'll lead to: WAR!

Maybe it will. It seems like someone is determined to undermine the US financially and once widespread depression hits then people in the US will support war.

God bless America!

Randy said...

Anon 5:40,

Thanks for posting up-agreed... Many haven't a clue, but once it impacts their standard of living, maybe they'll actually open their eyes and take interest.


I don't even think it will take a depression - A Major downturn including significant unemployment or even stagflation/hyperinflation will allow the mainstream to garner the required support.

Many propose that Bush won't leave the IRAN problem to another administration. Could be--Wonder just how bad our economy will be by late 08?

Personally, I think significant MBIA and AMBAC downgrades could be enough to do the trick...

John said...

Good piece. I sold all my stock when the Dow started to approach 14,000. New highs, growing sub-prime crisis, and the ever looming debt kept me awake at night. I pretty much sensed things were going to get cheap in a hurry.

However, I was not exactly clear about the dangers facing the US dollar. I did wonder if I should buy Gold, Silver and foreign currency. But I never made the move.

Metals have risen a lot since then. But, I'm still thinking I ought to buy Gold and Silver.

What are you all thinking?

Randy said...


Not investment advice, merely my opinion regarding Gold. Note: I think Silver may be even better...

Gold was $35 an oz back in 1971 and soared to over $800 in 1980. So, lets say it increased 23 times in price.

That same $800 inflation adjusted 1980's price(using the gvts skewed inflation figures) would be ~ $2200today. If you were to use THE REAL INFLATION RATE (see shadow government statistics) we'd be closer to $5K an oz.

Lets look at it another way. The bottom of the last cycle was ~ $250an oz. If the same set of events were to transpire today and we started with $250oz and then multiplied by by the same factor of 23, we could expect a top of ~ $5,700 oz.

With that now said. Back in the 70's/80's we were a net exporting country, had minimal national debt and actually had a positive national savings rate.

Today the fundamentals are much worse than the 70's/80's.

Additionally, it took the cajones of Fed Chairman Volcker and nearly 20% fed rates to kill the gold run and restore the US Dollar.

Bernanke's hands are tied and the is ABSOLUTELY NO WAY this could be done again without sending the world into a DEEP DEPRESSION.

Bottom Line: I think gold is still a good buy. Wait for a nice corrective dip ($850-$875)and then back up the truck. In 3-5 years,I think you'll be glad you did.

Oh,one final Note--BUY PHYSICAL if possible. If the system crashes, you have it in hand and will not be dependent on someone else's losses, liquidations, liabilities, lies/deceit and/or timelines.

A highly recommended link (non-commissioned, no pressure sales people) on the right side of my page. for Ken Slater... I've dealt with him several times in the past and he really seems to be a man of integrity and knows his stuff.

regards and good luck

John said...


Agreed. I am still thinking gold and silver. Of course, I am also hesitatant to put all my eggs in one basket. I am pondering TIPS, yet I am not sure they are a good bet. After all, as you said, the Government's inflation numbers are artificially low, never mind concerns about the US dollar in general. If I can figure out one other place to put some money outside of metals, I may take the plunge. Bonds are a concern if things get really bad. And I simply can no longer discount this possibility.

Anonymous said...

This is like the book "who moved my cheese"

The world is changing. We need to adapt. Oil is dwindling, it will keep going up in price and so will gold. We need to adapt. We need to live within our means. We need to innovate. Rather than be part of the problem, we can be part of the solution. We need alternative fuels. Things that don't come from food sources, like ethanol. The one silver lining in hiher priced oil is the demand and investment that will go into alternative fuels. If we get there first, and on a grand scale, then the world will change again. Gold will need to help the middle east, russia etc because frankly, we won't need their oil. They will then have to adapt... and so the world turns...

Randy said...


If you want to know how understated inflatin is, see my link "Inflation or Hyperinflation" on the right side under Most Popular.

Agree with your concern w/Bonds--expecially if AMBAC and MBIA get downgraded.

Anon 7:31,

Good points and yes I read "Who moved my Cheese" Valid in this scenario. Thanks for posting up.

John said...

What to do you folks think of some of these basic argument against our concerns:

1). As the dollar continues to sink your imports shrink and your exports boom.

2). Underlying economic strength of the economy validates continued large credit levels.

3). America is the productivity frontier and continues to have rapid productivity increases.

faberm said...


Your analysis is thorough and stunning. I received my Master of Economics some 30 yrs ago, and I never dreamed I would live to see the events unfolding. Thanks for your contribution.

Randy said...


As a non-economist myself (my degree's are in engineering and telecommunications) your compliment has to be one of the best I've ever received.

I too am very worried about our future.



Anonymous said...

Your "projections" of what will occur, which are supported by an extensive collection of "facts" and some decent extrapolation, certainly sounds logical.

However, the "wild card" at the end of all logical projections is the human right brain, an out of control, capicious organ which will eventually screw up everybody's projections of possible events.

On this backwater planet, it seems to me, "man" is performing the same self destructive acts over and over down through the centuries, and cops out by saying, "History repeats itself" as if history was a being with control and self direction. History is merely a record of man's successes and failures.

Ergo, every country has its time, and our time has been over for many years. The population is now under the control of an "authoritarian" state...not "Big Brother", but hundreds of thousands anonymous "Big Daddies" who control every thought, every more, every ethic with the goal of survival of all 68,000 governments within its borders, and their (estimated) 2.5 million agencies, departments, and bureaus.

It's just man repeating his's natural to this planet....the governments are parasites, and the population is the host.

Unfortunately, the parasite always outlives the host...not by much, but just enough.

So, accept the natural evolution of "state" - self destruction by eating its own innards.

We are no longer number one economically, industrially, or militarily...

Accept it, and do not worry about the's natural!


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Anonymous said...

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Unknown said...
This comment has been removed by the author.
Unknown said...

Hi Randy, i am new to your blog. Very informative. I am interested on your take on the US dollar being fiat money. Is it really fiat? Not according to Stephen Zarlenga in his book "The Lost Science of Money", but is really a debt-based currency issued by banks through loans.

Not that i understand what that means but a difference in thedefinition of fiat may materially impact your conclusions about the US dollar.

Randy said...

Guy - that statement is correct - credit is debt is fiat (money backed by nothing). I suggest you study this link a bit for a better understanding

Economic Outlook 2008-11+

Unknown said...

Hi Randy, i've read your US Economic Outlook 2008-11+. Awesome great work and analysis.

Allow me to play Devil's Advocate and go back to Stephen Zarlenga's definitions. That's just his point, fiat is not the same as debt or credit. He said we should be able to differentiate between fiat money and credit/debt.

Anonymous said...

Hi Randy,

You posted this Jan 25, 2008.
Now here we are, Nov 20, 2010 and it's all happening just the way you laid it out, in your closing remarks. I saved this article to review from tme to time. It helps me stay focused and not loose sight on where we are heading as a country. Thanks, Mike

Anonymous said...

Dearest Randy Thinking that we have 3 years before a dollar crash is LOL...wildly optimistic. Price of Gold & Silver are indicators of a nations sickness..the U.S. To put it in another way We Are Toast and the other nations are really realizing that and will accelerate the final collapse. See my web site Learn Spanish, move to southern Mexico and blend in real well. Good Luck. Thanks!

Unknown said...

America still is the greatest country on earth, the world has adopted American ideals as its own.

I would argue that the Arab countries of North Africa have adopted the American notion of democracy and have rejected their established leaders because they were not democratically elected.

Others would argue that it was because they couldn't afford to feed themselves.

God bless America!

Anonymous said...

This is Barry and it is not funny that when I first read this and "agreed" with you, I also thought you were a bit cavalier about precious metals. You spoke whimsically about purchasing gold on a dip at below $850 an ounce. Today we are nearly twice that. So amusing and just why didn't I simply go ahead and not wait for a casual dip and buy at $850? And you even said silver could be better, and that is so true. Miss hanging out with you on the lake.

Anonymous said...

Re-read your 2006 article and am amazed how accurate you were. Wouldl love to hear your views on our economy and stock markets for the next few years. Any ideas on where we should park our money to get some decent returns and protect and preserve our hard earned cash. Waiting for your detailed response.


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This comment has been removed by a blog administrator.
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