This is an excerpt from Counter-Intuitive Inflation. We’ll be posting sections over the first two weeks of October.

The Question I Can’t Answer is Timing:

I think we can all agree that as we close in on $250 trillion of obligations that this can’t possibly be paid. There is no level of taxation or asset confiscation that results in being able satisfy those obligations. Further, with Congress overspending by $2 trillion a year (cash), $8 trillion a year (including off-balance sheet liabilities), and facing another $1 trillion a year of extra interest expense, no one is even pretending to try to pay our debts. At some point, the US will either default on its debt like Argentina or Greece have done many times, or will simply print so many dollars that we pay what we owe in dollars that have little value. I believe we’ll end up with the second alternative which I’ll call a stealth default. I’m sure most of you are wondering when this will happen. I don’t know and it’s worth the effort to explain why.

First, nothing happens in a vacuum. Given the size of the US economy, it’s natural for many US citizens to focus on domestic finances. One reason the US has gotten away with obscene levels of currency debasement is because other governments and citizens of other countries want to hold US dollars. Imagine you live in Argentina. Dumping pesos to hold dollars is a fantastic trade when your inflation rate is over 100% annually. Most of you know I travel extensively. Let’s take a look at the currencies of some of the places I’ve visited the past two winters:

Argentinians, Nicaraguans, Colombians, and Costa Ricans love the dollar.

While there is still understandable huge international demand for the dollar, it’s still losing purchasing power. Over the last couple of years, there has been a lot of talk in financial circles about the strong dollar. If you’re a foreign exchange trader, that’s true. If you’re an American who wants to buy a home, buy groceries, or fill up your gas tank, you experience the dollar as weak and losing purchasing power. The easiest way to show this in a chart is to compare these currencies with gold:

When I say the dollar is the best house in a bad neighborhood, this is what that looks like.

Many people have been dismissive of discussions by the BRICS countries about creating a new reserve currency. While I acknowledge that doing so will be a challenge, that coalition has grown to include over three dozen countries comprising well over 50% of the people on the planet. I don’t know how or when they’ll make this work, but I do know that when more than half the world wants less exposure to the dollar, that means a decrease in future demand. At some point, the US will be unable to print the incremental trillion dollars and shove it down the throats of the rest of the world.

It’s beyond the scope of this piece, but Alexander Macris wrote a fantastic book about the creation and decline of the petrodollar called “Running on Empty”. In it, he explains why international demand for the dollar will decline in the future. He was kind enough to ask me to write the foreword to the book. If you’d like a complimentary copy, just click the above hyperlink.

The second reason I can’t give you the timing is these things can play out over decades or centuries. I know we’ve already hit unpayable and unsustainable, but don’t know when the bond market will refuse the next offering at pricing set by the Federal Reserve. (Technically, the market sets the pricing, but as of now, the fed funds rate still has great influence.) Reserve currency status has changed hands many times over millennia, but the best comparable the US has is Rome which was the world hegemon for centuries. Unfortunately, Roman politicians had the same appetite for debasing the currency that the US Congress has.

This is how a hard currency becomes a worthless fiat currency. Chart from Business Insider.

This is the decline in purchasing power of the dollar. Look familiar? This is history rhyming.

Rome spent 200 years debasing their currency. The creation of the Federal Reserve a little over 100 years ago began the debasement of the US dollar. That unfortunate process was accelerated in 1971 when President Nixon took us off the gold standard. Do we have another 100 years of dollar dominance left? I think that’s doubtful. The dollar won’t collapse and disappear in the next year either, but there’s no way we create a quarter of a quadrillion dollars of value that can be used to pay our obligations. So eventually, there will be a real default or a stealth default. That can’t be stopped.

 

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