Gyroscopic Investing

If we all of a sudden had an influx of dollars (as far as I can tell, a requirement of a rejection of the dollar), that would manifest itself as foreign demand for US goods, or at least a good chunk of it that way.  This means our trade deficit would very naturally shrink, and US balance sheets would repair naturally.

systemskeptic wrote: Currently countries throughout the world are holding dollars as part of their foreign reserves, are they not?  If these countries decide to stop holding these dollars, who will they sell them to?  Each other? Private Americans? The USG?  If they all decide to stop holding dollars, clearly they cannot sell to other foreign governments or it becomes a game of hot potato. 

Let's say you're China and you hold a trillion dollars in your reserve account at the fed. For whatever reason, you want to get rid of these dollars. Let's say for the sake of argument that the rest of the world does too, so you can't exchange your dollars for goods produced in Europe or South America or Japan or something. Hmm, who still wants dollars? Americans. So you can trade these dollars for American goods. But what if America doesn't produce anything you want? Then it looks like the Americans aren't going to take your dollars.

We don't have to accept the dollars. Trade is a mutual thing. If country A wants to dump dollars but can't find a buyer, they keep the dollars. They can't force them on us!

Now, maybe the Chinese will be so desperate that they'll simply give dollars away. But why would they do that? It would ruin their government's balance sheet! They're not going to diminish their foreign currency holdings for no benefit. That would be stupid.

The only way "all the dollars will come pouring back" is ironically if our economy really got pumping and we started running a trade surplus, which would mean that we were giving foreigners real goods and services in exchange for our own currency.

Pointedstick wrote: But what if America doesn't produce anything you want? Then it looks like the Americans aren't going to take your dollars.

Wouldn't this be #2 where the US defaults on the foreign dollars?  Otherwise Americans will still sell goods abroad, just for 100x, 1000x the amount of dollars they would have received previously.

moda0306 wrote: This means our trade deficit would very naturally shrink, and US balance sheets would repair naturally.

moda,

Very true, but while the balance sheets will look good [nominally] what will be the impact on those saving and earning in $USD?

Pointedstick wrote: Now, maybe the Chinese will be so desperate that they'll simply give dollars away. But why would they do that? It would ruin their government's balance sheet! They're not going to diminish their foreign currency holdings for no benefit. That would be stupid.

Now you see why this system is so difficult to unwind, and has been in place for 41 years -- you need something else on your balance sheet to offset the loss in value of all those dollars. 

At some point, China (and other countries) will be content with what that something is, and will be ready to dump their dollars.  This is already happening... slowly... in part because nobody wants to be politically responsible for triggering the hyperinflation/collapse of the $USD.  Luckily for US, it's been happening at a pretty steady rate of about 17% a year...

Hint: it's shiny and yellow

systemskeptic wrote:

Pointedstick wrote: But what if America doesn't produce anything you want? Then it looks like the Americans aren't going to take your dollars.

Wouldn't this be #2 where the US defaults on the foreign dollars?  Otherwise Americans will still sell goods abroad, just for 100x, 1000x the amount of dollars they would have received previously.

I'm not sure I would characterize "having nothing the Chinese want to buy" as "defaulting on foreign dollars." Trade isn't a bond; there was never any agreement to pay anything in the future. If you and I are nations, and you sell me a cars in exchange for pointed sticks, and then later want to get the pointed sticks off your balance sheet but I don't happen to sell anything that interests you, I haven't defaulted on your foreign pointed sticks. You've simply made a bad bet. Maybe I'll produce something you want in the future, but I have no obligation to produce goods you want to buy. That was never the agreement. There was no agreement!

systemskeptic wrote:

Pointedstick wrote: Now, maybe the Chinese will be so desperate that they'll simply give dollars away. But why would they do that? It would ruin their government's balance sheet! They're not going to diminish their foreign currency holdings for no benefit. That would be stupid.

Now you see why this system is so difficult to unwind, and has been in place for 41 years -- you need something else on your balance sheet to offset the loss in value of all those dollars. 

At some point, China (and other countries) will be content with what that something is, and will be ready to dump their dollars.  This is already happening... slowly... in part because nobody wants to be politically responsible for triggering the hyperinflation/collapse of the $USD.  Luckily for US, it's been happening at a pretty steady rate of about 17% a year...

Hint: it's shiny and yellow

Yes, absolutely, and that's why we hold gold! I agree with you and Slotine that the advantage of having the reserve currency cannot be understated. But I really just don't see an impending collapse. Whose currency going to take our place? The Euro is imploding. The Renminbi is controlled by an untrustworthy communist oligarchy. The dollar may suck, but as long as everyone else's currency sucks worse, I think we're pretty safe! I mean, it'll have to fall someday, but I think it will be fairly slow and probably not in the next decade or two.

The thing is... being the reserve currency requires enormous amounts of government spending, in order to provide liquidity to the entire world. It would actually be impossible to be the world's reserve currency if the government ran a surplus.

See: http://en.wikipedia.org/wiki/Triffin_dilemma

But, you don't have to be the world's reserve currency to maintain a fiat currency. You just have to run your country a bit differently in order to be a user of whatever the world's reserve currency is.

Pointedstick wrote: Whose currency going to take our place? The Euro is imploding. The Renminbi is controlled by an untrustworthy communist oligarchy. The dollar may suck, but as long as everyone else's currency sucks worse, I think we're pretty safe! I mean, it'll have to fall someday, but I think it will be fairly slow and probably not in the next decade or two.

If you look at the balance sheets of central banks / governments around the world, you will find they are already holding a common currency, and it's not dollars.  The problem is this particular "currency" is a lot harder to get a hold of, since you can't just print it yourself.

Remember that prior to 1971, dollars were synonymous with another [universal] currency.

Gumby wrote: The thing is... being the reserve currency requires enormous amounts of government spending, in order to provide liquidity to the entire world. It would actually be impossible to be the world's reserve currency if the government ran a surplus.

See: http://en.wikipedia.org/wiki/Triffin_dilemma

But, you don't have to be the world's reserve currency to maintain a fiat currency. You just have to run your country a bit differently in order to be a user of whatever the world's reserve currency is.

I am very interested to hear more detail on this.

Gumby,

You bring up a good point by linking Triffin's dilemma.  It is precisely the reason why nations cannot maintain their reserve status indefinitely -- the system is inherently unstable.  It is not possible to simultaneously maintain the deficit required to provide liquidity for a reserve currency and maintain credibility in that currency without a trade surplus.

Slotine's plot illustrates this historical fact.

systemskeptic wrote: Gumby,

You bring up a good point by linking Triffin's dilemma.  It is precisely the reason why nations cannot maintain their reserve status indefinitely -- the system is inherently unstable.  It is not possible to simultaneously maintain the deficit required to provide liquidity for a reserve currency and maintain credibility in that currency without a trade surplus.

Slotine's plot illustrates this historical fact.

I agree that the system is inherently unstable. But, I'm not sure you need to have a trade surplus to have "credibility". If you have a really big military, that helps with credibility.

I'm not saying a big military is a good thing. Just pointing out a reality.

systemskeptic wrote:   It is not possible to simultaneously maintain the deficit required to provide liquidity for a reserve currency and maintain credibility in that currency without a trade surplus.

Slotine's plot illustrates this historical fact.

I'm not sure I follow this logic. The countries need to get dollars in order to use it as a reserve currency. Our trade deficits are how these countries get our dollars. How would not giving them dollars make it more credible as a reserve currency? Wouldn't that make it less credible? Surely we could over do it and flood the world with dollars, but a reserve currency that doesn't have any supply growth would lead to international crises.

melveyr wrote: How would not giving them dollars make it more credible as a reserve currency? Wouldn't that make it less credible?

It's a balancing act between liquidity and credibility, but ultimately the point of a reserve currency is to store value.  If the credibility of that value erodes/evaporates due to trade deficits / debt (you realize it will never be paid back) then what you have is what we are experiencing today - the unfolding of that system.

systemskeptic wrote:

melveyr wrote: How would not giving them dollars make it more credible as a reserve currency? Wouldn't that make it less credible?

It's a balancing act between liquidity and credibility, but ultimately the point of a reserve currency is to store value.  If the credibility of that value erodes/evaporates due to trade deficits / debt (you realize it will never be paid back) then what you have is what we are experiencing today - the unfolding of that system.

You don't think that the rest of the world is trying to devalue their currencies as well?

I don't think the U.S. dollar is all that great...until I look at everything else in the world.

Emelianenko wrote: I find mmr to be a fascinating subject that I know very little about. For instance, I feel like the massive increase in debt has probably made the financial system less stable, I couldn't tell you why, that's just how I feel. Could anyone possibly point me to a link that discusses this?

https://papers.ssrn.com/sol3/papers.cfm ... _id=161024

systemskeptic wrote: If the credibility of that value erodes/evaporates due to trade deficits / debt (you realize it will never be paid back) then what you have is what we are experiencing today - the unfolding of that system.

Of course it will be paid back. That's the difference between currency issuers (USA, UK, Japan) and currency users (Greece, Spain, the U.S. states). Now, inflation may cause it may be paid back with less-valuable currency, but that's a BIG difference compared to not being paid back at all. The markets are worried that Greek and Spanish debt won't be paid back at all, as evidenced by their bond yields. What do U.S. treasury yields say about the bond market's feelings on the likelihood of receiving the promised payments?

Pointedstick wrote: Of course it will be paid back. That's the difference between currency issuers (USA, UK, Japan) and currency users (Greece, Spain, the U.S. states). Now, inflation may cause it may be paid back with less-valuable currency, but that's a BIG difference compared to not being paid back at all. The markets are worried that Greek and Spanish debt won't be paid back at all, as evidenced by their bond yields. What do U.S. treasury yields say about the bond market's feelings on the likelihood of receiving the promised payments?

It cannot be paid back in real terms, which is what establishes credibility.  Nominal doesn't matter.

You are making the assumption that interest rates are an accurate measure of the credit worthiness of a currency.  Is this true in all cases?  What about when the USG is buying it's own bonds (driving down yields) or there are other short-term factors such as flight to safety, crisis  in Europe, etc.

The $USD comprises 60% of the world's foreign reserves, but that number has dropped 15% in only the last 10 years [since the introduction of the Euro].  The trend will continue (for our sake, hopefully not too fast) because there is no way the debt can be paid back in real terms.  Most realize this, but nobody can fully act on it because it would trigger the hyperinflation/collapse of the dollar.

In a way, you could say the $USD is already hyper-inflated, it's just the vast majority of the currency has a velocity of zero because nobody is willing/able to exchange it.

Pointedstick wrote: Let's say you're China and you hold a trillion dollars in your reserve account at the fed. For whatever reason, you want to get rid of these dollars. Let's say for the sake of argument that the rest of the world does too, so you can't exchange your dollars for goods produced in Europe or South America or Japan or something. Hmm, who still wants dollars? Americans. So you can trade these dollars for American goods. But what if America doesn't produce anything you want? Then it looks like the Americans aren't going to take your dollars.

We don't have to accept the dollars. Trade is a mutual thing. If country A wants to dump dollars but can't find a buyer, they keep the dollars. They can't force them on us!

Now, maybe the Chinese will be so desperate that they'll simply give dollars away. But why would they do that? It would ruin their government's balance sheet! They're not going to diminish their foreign currency holdings for no benefit. That would be stupid.

The only way "all the dollars will come pouring back" is ironically if our economy really got pumping and we started running a trade surplus, which would mean that we were giving foreigners real goods and services in exchange for our own currency.

I would imagine someone has already said this...I haven't made it to the end yet, but what you are describing is a currency collapse/hyperinflation.  This is how it happens.  You have a very large supply of currency and very low (no) demand for it; therefore, you can't buy anything with that currency, which means that the price of goods in that currency goes to infinity.

MediumTex wrote: You don't think that the rest of the world is trying to devalue their currencies as well?

I don't think the U.S. dollar is all that great...until I look at everything else in the world.

Ahh, the prettiest corpse at the funeral again!

Slotine wrote:

Pointedstick wrote: We don't have to accept the dollars. Trade is a mutual thing. If country A wants to dump dollars but can't find a buyer, they keep the dollars. They can't force them on us!

Yes, you do.  Circa 1976 UK.  Importing goods require the disposition of other foreign assets and the replenishment of the balance sheet with the domestic currency.
...
But history shows that you also don't need hyperinflation.  The UK GBP got replaced as a reserve currency over a long period.  Probably one of the most beautiful and calmest retirements in history and through a great cooperative effort from all those involved.

Yes, it worked out quite nicely for the U.K.  There were comparatively few pounds in comparatively few countries and most of their history as a reserve currency was during gold and silver standard, and most of their transition away was to another country that promised to be a gold exchange standard.  US.

I hope our transition away from being the world's reserve will work out as smoothly for us.  It doesn't always work out so nicely...  Spain, France, Germany, Rome...

The process for us is likely to be that China and Japan (the two largest foreign holders of U.S. debt/dollars) want out (kind of like 2010-2011), the U.S. won't let them buy what they want to buy (like the port authority purchase and a few others that have been nixed), so they use their dollars to buy anything else on the world market (kind of like what they have been doing with natural resources and mines of all kinds, surplus war machines, etc).

This increased buying (increasing the velocity of the formerly frozen dollars) drives up world prices, or in other words, drives down the value of the U.S. dollar.

As long as it happens slowly enough, the rate of inflation/rate of decline will be gradual enough that everyone can become accustomed to the new reality of dollar shrinkage.  But that requires a lot of restraint.  (The U.S. experienced about 100% inflation over the 1970's, and that took several years afterwards for people to "get used to it.")

Not just restraint on the part of China and Japan and the other holders of U.S. debt.  But also on the part of the U.S. to limit the creation of new money.  Because both the new money and the old money must be absorbed (preferably frozen, but at least not handed off quickly too many times), and thus both will contribution to inflation.  So far we haven't often had to contend with much of the old money coming on the market in the U.S. or for things we want to import.  The past few years have been a new experience.

So one question is, what will China et al do (accelerate their pace of disposal, or slow it and accumulate more dollars), and when?

The other question is, will we adjust our pace to compensate for them?

Just keep your eyes open.  It might go slow.  It might not.

As long as other countries are more inept in their fiscal and monetary policy than the USA, then the velocity for USD will keep inflation in check.

Rome took thousands of years to fall.  You had plenty of time to get the hell out of Dodge.