What is a world reserve currency? It is a large amount of currency held on deposit by the US central bank and large regulated financial institutions which is intended to be used for investments, international trading transactions, and settlement of international debt obligations. Reserve currency serves to influence/affect the domestic exchange rate with currencies from other countries. The current status of the world reserve currency is currently held by the USA because of prior agreements and the continuing strength of the dollar.
Historically, the status of the holder of the primary world reserve currency at an international level may come and go, be shared with top competing currencies, or replaced entirely with a different one. For example, the International Monetary Fund, an international organization that was created at the same time the Bretton Woods Accord was implemented, established a system referred to as special drawing rights where the participant members could borrow similar to how the US regulated lenders could borrow from the Federal Reserve. The (SDR) basket is determined by predetermined formulas from currencies of U.S. Dollar, Euro, Chinese Yuan, Japanese Yen, Pound Sterling. The fixed number of units contributed by each currency is reevaluated each 5 years period. The IMF was originally established by 29 participating countries at the Bretton Woods Conference.
Today, its participants have grown to about 183 countries. Any new currency standard could be negotiated between the stakeholder participants or forced upon them depending on what forms of governments are involved.
How did the USA attain the standard of the world reserve currency holder? After WWII a new international financial system was created at a meeting by a formal agreement that becomes known as the “Bretton Woods System”. Participants who consisted of world leaders included representatives from 44 different countries in 1944. The USA negotiated that the dollar should be held as the world reserve currency standard because the US agreed that the dollar would be backed by Gold. At that time the US had 65% of the worlds’ supply of gold and was pegged at $35 per ounce. The US negotiated the anchor status because it guaranteed to other central banks that it could sell its gold reserves for settlement purposes. Many conflicts arose between the economic interests of short-term domestic objectives and long-term international objectives.
At the same meeting in 1944, the World Bank was created to become an important source of financial aid for developing nations. The goals were to provide financial resources to create a path of stable, sustainable, and equitable growth to lift countries out of a poverty existence. The World Bank is an independent organization of the United Nations and the US has a tremendous influence on its operation and success.
Today, there is a major pressure from financial stakeholders around the world that suggest the US is about to lose its status as a world reserve currency holder. The two major reasons are: In 1972 President Richard Nixon unilaterally canceled the gold standard conversion option. This meant that all future transactions backed by or pegged to the dollar would be no longer be backed by gold, but only by the full faith and strength of the US Government. At that point, the Bretton Woods system effectively fell apart. The second reason was and continues to be that the US has historically financed its deficit spending by continually issuing new debt instruments that international financial participants have been willing or not so willingly forced to purchase. Other countries have effectively been forced to finance US deficit spending and remain quiet about excesses and wastefulness. The reliability that other countries will continue to finance our debt has come to an end.
The US takes in about 3.5 trillion in taxation and spends roughly 4.5 trillion on all government programs and debt service on the books including accrued direct debt. That means that the government creates new debt instruments of between 1 and 1.5 trillion annually. That has compounded to approximately 22 trillion on the books of direct debt which is expected to be paid back by the US taxpayers. Additionally, the US has off-balance-sheet accrued debt obligations including unfunded pension obligations, Medicare, Medicaid and other unfunded financial obligations of approximately 220 trillion. All the above direct debt and accumulated unfunded future obligations are accelerating at an alarming rate.
The world financial participants are getting tired of being forced to use the dollar to complete business transactions and settle their obligations. Transactions from all over the world must be settled by adjusting their currency value to that of the US dollar.
Many see the US as a spoiled child, having used the negotiated superior status of the dollar to gain additional unearned toys. Many world economic participants believe the US standard of living is financed on the backs of non-beneficiaries and operating from a false status of privilege. Major economic powers including China, Russia, India, Turkey, Brazil, EU, and others are currently in the process of attempting to replace the dollar-reserve exchange system with a different one. They will most likely use a combination of national currencies to create the new reserve system. Their intention is to circumvent and make the US system irrelevant.
Most Americans have grown accustomed to the US having dollar strengths and having a good standard of living as a result. The government has financial tools available to prop-up the strength of or weaken the dollar as desired. But what will happen one day when the US wakes to find that its privileged status has been circumvented? What happens when world economic participants refuse to buy any more of US compounding debt? This may occur over an intermediate time frame such as 3 to 5 years. Some will argue that the end is closer. The spoiled rotten kids are going to be knocked down quite a few notches. What will happen when the kids wake up and find that they can no longer spend 25% more than they take in, and use unlimited credit cards and continuing to accrue short-term and long-term debt?
The value of the dollar will drop “like a rock”. The US government only has so many financial methods to prop up the dollar. All of a sudden, the US could be forced to get serious about eliminating deficit spending and to cut-up the unlimited credit card. You can image the day that our leaders must tell the populous the ugly truth that the US will cut spending by 25% across the board. You have heard the terms, “squealing pigs.” All the false entitlements, unearned freebies, corporate crony handouts, tax preferences for friends of the system, and free lunches will cease to exist. Since about 2/3rds of the population look forward to government transfer payments and redistribution benefits in multiple forms, there could be riots on the street. “You can’t take away what I am entitled to, even though I did not work to earn it.”
All products, goods, and services will cost more because the value of each dollar will go down. How much depreciated value will occur of the dollar’s purchasing power remains to be seen. My guess is that our purchasing power could go down by 40% to 50% in a 3 to 5-year time frame. The question remains if and when. Also, if nothing is done hyperinflation will eventually erode all quality of life in America except for the top 1% who will continue to make money on financial repression.
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