The hardest tumble a man can make is to fall over his own bluff – Ambrose Bierce
I’ve been reading analyses about the death of the dollar for thirty years. Over that span, I witnessed the death rattle of the monetary aggregates and the conversion of the Federal Reserve from stewards of money supply to institutional asset inflaters. But it’s only been my work on the Eurodollar over the past fifteen years that has taught me that nobody has any clue about money supply. As Jeff Snider of Eurodollar University once said, it makes the term “quantitative easing” so laughable because there is nothing quantitative about it.
I don’t know how many dollars are in existence but I do know that the Eurodollar system built China, supplying the initial capital and all of the imports of minerals, technology and machinery. Having covered banks in my youth, I know the how money comes into existence as well as how money gets destroyed. This is where I think the vast number of doomsayers get it wrong. Or maybe they get it right but for the wrong reasons. Either way, the death of the dollar as global reserve currency will come when the dollar becomes too scarce for broad usage which is the opposite reason given my most pundits.
Death of the Petrodollar
It is much easier to be critical than to be correct – Benjamin Disraeli
The Petrodollar system was all about trading exclusively in dollars in return for market access and protection. It was a great deal for the Middle East, Europe, and Africa. The Middle East enjoyed the upper hand for a short time in the 1970’s until the market adapted to higher oil prices with greater fuel economy and new discoveries.
Some would have us believe that Saudi Arabia holds the Sword of Damocles over Uncle Sam’s neck but that is entirely false. The reality is the other way around. Saudi Arabia needs a Sugar Daddy to protect it and more than anything, they want dollars to flow into their coffers. The sad truth for SA is that the economic viability of shale oil and gas means that the US no longer needs them.
The Gulf kingdoms all want dollars for their oil, so does Africa and South America but the US produces its own oil and is in fact exporting natural gas, which further drains dollars from the global banking system. People talk about the BRICS as if they are a powerful cartel instead of a group of economic basket cases, with the exception of India.
Go ahead and accept Russian rubles, Chinese yuan, Indian rupees, Brazilian real, or South African rands in exchange for oil. How about Japanese yen? European euros? They are all vastly inferior to the dollar and the Saudis know it. How would you like to have held Indian rupees for the past 15 years?
The Saudi’s need buyers for their oil and natural gas plus they need a military power to protect them. They have a military with the latest equipment but it is staffed by mercenaries with little motivation to risk life and limb. The US has made it clear that we no longer wish to provide that service thanks to our own deposits of oil and gas.
China is an option for the Saudis but that would entail taking yuan in exchange for oil and eventually becoming a vassal state. Where Uncle Sam has applied a gentle touch to Saudi politics, Uncle Xi would employ an iron fist.
Thanks to a weakening global economic climate and new discoveries in North America, the world is awash in oil and that means that individual producers have little channel power. Despite a sharp increase in global inflation and war in Ukraine, the price of oil is flat over the past 15 years. This implies Saudi is a price taker, not a price setter. If they ultimately choose to be compensated with a BRIC currency, it means they failed in attracting dollars for their exports.
It's the same for the rest of the Gulf states and Nigeria. Commodity exporters need global economic expansion for oil to price at a premium. For the past 25 years, China has represented the marginal buyer in world markets due to its uncontrolled growth but the collapse has started. The private sector, which employs 90% of Chinese workers, is being squeezed for money by the CCP while international buyers go elsewhere. China’s long-awaited crash is here. The result will be a decline in the price of oil, absent a global war.
The Petrodollar is dead but the people who claim it’s because the world is awash in dollars have it wrong. The Petrodollar is dead because the US no longer needs to import oil. We’re no longer shipping vast amounts of dollars to the Persian Gulf. By extension, this implies that the global economy has insufficient dollars to drive growth.
Destruction of Eurodollars
The way you create deflation is you create an asset bubble – Stanley Druckenmiller
I’d like to amend Druckenmiller’s quote by adding in making terrible loans that have no chance for success. As it relates to the Eurodollar, these markets are only lightly regulated and the size of the market is unknown yet all the international banks are in the market. What could go wrong?
Most experts (?) guess the quantity of Eurodollars is roughly equal to the quantity of domestic US dollars. This makes the dollar unlike any currency that has ever existed in history and the reason you can’t analyze it the way you analyze other commodities. A couple hundred years ago, a merchant would be happy to accept Dutch guilders in trade because he knew that the guilder could be exchanged for gold. The same with the British pound.
The dollar was exactly like the guilder and pound until President Nixon closed the gold window in 1971. For 53 years, the US dollar has become the Frankenstein monster of reserve currencies. It’s one of a kind, an aberration of nature. Furthermore, the explosion of derivative contracts, new forms of monetary assets, and, the aforementioned inability to quantify the supply of Eurodollars has taken the dollar three orders of magnitude away from the 19th century British pound. With this in mind, is it possible that we could be facing severe deflation starting with the Eurodollar despite US profligacy? Is it possible that US Treasury bonds prove to be scarce when the deflationary event hits?
Modern Monetary Theory
The first panacea of a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists – Ernest Hemingway
MMT is what happens when Congress wants to spend money and turns to crackpot academic economists to create a unified economic theory to allow them to do what they want. Rejecting MMT should have been an easy layup for anyone who has followed Third World economies over the past 50 years. Prior to modernity, weak despots have been employing similar policies far back into antiquity – always with the same result.
Right on schedule, we’ve got domestic inflation. You know it’s obvious when a Fed Chair calls out the government for unsustainable spending as Powell did last December. Looking back, we started embracing MMT in stages following the crash of 2008 and it has gotten progressively worse. This reliance on government spending has empowered the Marxists in our ranks. Marxism is a disease that seems to recur every 50 years or so.
The White House always wants to spend more which is why Congress is supposed to be the keeper of the purse. This is why I put the blame squarely on Congress – both sides of the aisle. The wrongfully named Inflation Reduction Act of 2022 effectively gave the White House a blank check to keep the MMT train rolling through this year’s election. Without this spending package, we would undoubtedly be experiencing a recession today.
To complete Hemingway’s quote, the drums of war are beating extra loudly in the Middle East, Ukraine, and the South China Sea. Even the Germans and the Japanese are starting to re-militarize, which is something we need to watch closely in the future.
US Treasury Bonds
The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default – Alan Greenspan
Many of the finest financial minds are telling us that the world will eschew new US borrowings due to the extraordinary excess that has piled up over the past fifty years. While a credible thesis, I expect the opposite in the near term. I believe the market is going to scramble for US Treasury securities as well as Fannie/Freddie and other agencies because these are the preferred securities in the repo market.
No, I have not lost my mind and no, I have not become an apostate who has turned from Adam Smith, von Hayek, and Milton Friedman. Instead, I view US Treasuries and other sovereign debt as the foundation of our insane financial system. When deflation starts, Treasuries and agencies will be the only acceptable collateral because the world will attempt to dump credit risk.
If the Fed plans to execute another magic trick to save the markets, it’s going to start with Treasuries and Agencies. This will create a mad scramble for government debt and a push back to 0% interest rates which will take enormous pressure off US debt servicing costs. I expect the 10-year Treasury to trade below 1% again before this is over.
Yes, we are paying over $1 trillion in debt service each year but that number will collapse when financial repression kicks into fourth gear. A bad domestic recession combined with worse weakness in Europe and economic depression in China will take enormous pressure off consumer prices – initially.
Over the longer term, I agree with the analysts who expect a massive devaluation of global currencies but before that happens, I expect one more giant opportunity for principal gains when long-term interest rates fall.
Crypto A Trojan Horse
There are no rules of architecture for a castle in the clouds – G.K. Chesterton
Crypto currencies are one stroke of the pen away from being worthless. So why have they garnered so much investment? To understand, we turn to Machiavelli. How would Machiavelli counsel a prince to treat such a threat to his power knowing control of the money supply represents the ultimate economic power in a system?
Crypto serves the government in two ways. The first is that it takes pressure off precious metals and commodities. It gives investors an outlet to vent their frustration with global central bank policies.
The second reason is that it represents a Trojan Horse for central bank digital currencies (CBDC) and CBDC’s represent the ultimate tool for financial repression because it allows the government to see EVERY transaction that occurs in the system. It represents the culmination of threats forewarned by Orwell and Rand.
This is the true value of AI because the combination of CBDC’s, AI, and an empowered IRS would be the last piece of the puzzle for fully centralized control to be realized. It also represents the death of liberty and a move towards Marxism. Nvidia and their ultrafast GPU’s make it all possible.
Conclusion
On the road from the City of Skepticism, I had to pass through the Valley of Ambiguity – Adam Smith
Too many people have a romantic notion of the BRICS wannabe cartel as counterweight to the US dollar and US hegemony. They’re wrong. China, Russia, and South Africa are collapsing economically as I write this. Brazil will follow before much longer.
Holders of crypto need to ask themselves why global governments are allowing them to grow? There is one credo that has never failed me when analyzing governments; nobody gives up power willingly. Will governments allow Bitcoin to be converted into their digital currencies when the flood hits? I know that it would be relatively simple for US, European, and Japanese lawmakers to make crypto illegal in their respective economies.
Deflation has been the approaching train in the distance for 20 years that is now entering the station. The Eurodollar system is the least understood yet most important variable in the global financial system – and it can’t be quantified. It can’t be modeled. The Black Box has no answers.
Other than gold, there is no escape hatch and gold is a target for bureaucrats and criminals. I believe that we need to approach the coming bad times in stages and the first stage will likely favor US dollars and US Treasuries.
