This is part two of how the world ends—at least according to those who want to make a buck off of someone else’s fears. Make no mistake, I am fully supportive of worrying about things—they don’t call me Eeyore for nothing—but if you’re going to worry, you need to be sure that it’s something actually worth worrying about.
I talked yesterday about how the government has better, or at least easier, options available than to confiscate private retirement accounts. Though it could conceivably happen—Argentina has done just that—it isn’t in the cards here because we have a much more robust political and legal infrastructure, as we have just demonstrated.
The next most common disaster thread is the collapse of the dollar. This is actually something that requires a little more definition, as most of those predicting it do not actually say what they mean.
First, what does collapse mean? For the dollar to collapse, it would have to be worth substantially less with respect to other assets. What could cause this to happen? One possibility would be if there were an enormously large supply of dollars around while the available amounts of other assets remained constant. This scenario is inflation/hyperinflation, which I will deal with tomorrow, so let’s punt on this for the moment.
The other reason that the dollar could collapse would be if suddenly market participants were unwilling to accept it in exchange for other goods. What would happen, to use an often cited example, if OPEC countries refused to accept U.S. dollars for oil?
The short answer is that it would be bad. But before we get to that, we have to ask what the OPEC countries would want instead. This gets to the heart of the problem for any dollar-collapse scenario. What would be the alternative?
For the dollar to collapse, demand for dollars would also have to collapse. For that demand to collapse, either commerce would have to cease, or there would have to be an alternative currency to use. That alternative would have to have the following characteristics:
- It would have to be liquid in very large volumes.
- It would have to be stable.
- It would have to have a supporting securities market that allowed any currency surpluses to be invested wisely.
- It would have to be freely exchangeable.
- And, finally, it would have to be freely traded and not manipulated by the issuer.
Let’s look at the first requirement—liquid in large volumes. This cuts out most currencies, as well as gold. Among the world currencies, only the dollar, the euro, the yen, and the yuan/renminbi have anything close to the required volume. The others are simply too small to fill the needs of commerce on a worldwide basis. This will not change, either, as the available volume of a currency depends on the size of the underlying economy. It is no coincidence that the viable currencies are from the largest world economies; it is a prerequisite.
Among these currencies, stability is the second line in the sand. At present, the euro is certainly not economically—and arguably not politically—stable. Japan is not economically stable, with a debt-to-GDP ratio well in excess of the U.S. and deteriorating demographics. The euro could conceivably become a competitor if both economic and political issues were solved, but that is a next-decade possibility.
The dollar and yuan/renminbi then are the last two standing. I will give China a pass on the political stability argument (although I have my doubts) and move on to the last requirements. China does not have a large enough liquid and transparent securities market yet, which makes it difficult to invest any currency surpluses that a trader accumulates. The U.S. does. Say what you will about the Treasury market, it is the largest and most liquid market on the planet. Next, the dollar is freely exchangeable—less so for the yuan/renminbi—although China is moving in the right direction. Finally, the dollar is freely traded, and the U.S. government does not (explicitly) manipulate its value. Again, for a holder of the currency, it comes out ahead of the yuan/renminbi.
The yuan/renminbi is clearly becoming a more attractive alternative to the dollar, but as of right now the dollar retains significant advantages. For the dollar to collapse, there would have to be a substantial reason for investors to change their preferences, and at this point it is hard to say what that would be. One example of the robustness of the dollar is the difficulty that Iran has had in selling oil for nondollar assets. It can be done, but it costs a lot and is much less desirable than a simple dollar purchase, given the lack of commercial infrastructure.
The other option would be for a mix of currencies to replace the dollar in international commerce. This is certainly possible, but again it would vastly increase costs and reduce efficiency. The European Union created the euro to avert just this problem, and using multiple currencies in global trade would cost a lot more than the present arrangement. Economically, this makes no sense. Again, Iran trying to sell oil is the awful counterexample.
Could a dollar collapse happen? Certainly, but other things would have to happen first, none of which are on the horizon. Should Chinese capital markets become more developed, should the yuan/renminbi be allowed to float freely, or should Chinese capital controls be removed, then it might be time to start worrying. But none of those things are happening, so I am far more concerned about managing my dollars than exchanging them for something else.