Will the US dollar be replaced by Chinese yuan, SDRs, or gold as the main global reserve currency any time soon? According to Richard Duncan, well-known author, market strategist, and publisher of MacroWatch, the answer is a resounding "no".
In a recent podcast interview with Financial Sense, Duncan explains that the current global monetary system is unstable and that we are living in a massive credit bubble facilitated by a fiat (unbacked) dollar standard. The only way, however, to avoid a “Mad Max scenario” of global economic collapse is for the US to increase—not decrease—its trade deficit with the rest of the world.
During the interview, Duncan also explains the historical origins of our current monetary system and why proposed replacements to the dollar as the world's reserve currency—whether Chinese yuan, SDRs, or gold—will not work currently or any time in the near future without disastrous consequences, he argues.
Rapid Expansion of Global Credit and Trade
According to Duncan, the US dollar replaced gold and allowed for a rapid expansion in global credit and trade since, unlike gold, the dollar (or fiat money in general) is not a scarce commodity.
With the dollar acting as the world's reserve currency, American trade deficits, like those with Japan during the 1980s or with China more recently, helped fuel an economic miracle in many parts of Asia and the developing world, as liquidity flooded into the banking systems of those countries. As a result of these trade deficits, the US “threw nearly 10 trillion dollars off into the global economy between 1980 and today,” Duncan states.
While Duncan concedes that the flexibility of the dollar standard played a large role in the strong economic growth of the last 50 years, the system possesses vulnerabilities. The biggest of these arises from the simple fact that Americans can’t go deeper and deeper into debt to finance expansion of global liquidity and credit.
For example, the world is still struggling with the decline of the US trade deficit, which peaked in 2006 at 800 billion dollars. For Duncan this was the main cause of the 2008-2009 Global Financial Crisis as overindebted Americans pulled back on imports, which not only contracted global trade but also the free flow of dollars abroad.
The U.S. trade deficit still has not returned to 2006 levels, and is currently around 450 billion. Duncan notes: “the flaw with the dollar standard is the U.S. can’t keep throwing more and more dollars year after year into the global economy. The American consumer can’t keep taking on more debt all the time, their wages haven’t been going up... There is just not enough liquidity to make the global economy grow [without the dollar].”
Still No Replacement in Sight
For those who would point to the Yuan as a potential replacement for the dollar, Duncan responds that “no other country is going to run large enough trade deficits" to grease the gears of global trade. China, for one, currently runs a trade surplus with the US of several hundred billion dollars a year.
The same reasoning explains why both gold and SDRs (Special Drawing Rights issued by the IMF) cannot replace the dollar: in the case of gold, current US gold reserves would not even finance one year of America’s trade deficit, and in the case of the SDR, it would only hold the US over for a few months. After that, global trade would collapse, since the US plays such an important role as a global consumer of goods and services.
Without the dollar, “the whole global economy would implode,” Duncan states bluntly. He further predicts that trade deficit growth financed by dollars “will persist…and everybody had better pray that it does because the dollar standard could collapse but that doesn’t mean that something will replace it as the foundation of global prosperity.”
Solution = Larger Trade Deficit
For a solution, Duncan states that “if the US really wanted to rev up the global economy they could borrow more and run up a bigger trade deficit…possibly another 17 trillion dollars.” Duncan points to Japan as an example of a major country that has not collapsed with a trade deficit more than double that of the US in percentage terms, and as an emergency measure, Duncan feels the US government could do the same, given the incredible importance of the US dollar to the rest of the world. What’s more, since 10 year Treasury Notes only cost about 2 percent in interest, Duncan asserts “that there is effectively no limit to how long the US economy can borrow and grow.”
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Link to interview: Richard Duncan on the Dollar Standard – No Replacement in Sight