The Investment Scientist

What If The Dollar Lose Its “Gold” Status

Posted on: August 9, 2019

For the final article of this macroeconomics series, I want to write about something that is much more relevant to your financial wellbeing, whether you are a wage earner or business owner. That is, what would happen if the dollar loses its status as the predominant reserve currency?

The Quantity Theory of Money states:

M/P = kY where

M is the total money supply, P is the gross price level, and kY can be interpreted as the demand for money.

If the dollar loses its “gold” status, central banks around the world will need much fewer dollars and the demand kY for the dollar will drop. To balance this out, either the gross price level P will increase, or the total money supply M will have to be reduced. To put it in layman’s terms, we will get hyper inflation and hyper interest rates, the latter to reduce the money supply.

Let’s look at a historical precedence. See the chart below

unnamed (10).png

Between 1978 and 1979, the dollar’s share of world reserves dropped by 18%! going from 84% to 66%. The accompanying inflation and interest rates in the US are shown in the table below.

unnamed (11).png

The dollar’s share of world reserves bottomed out in 1991 at 46%. It gradually climbed back to about 70% in 2000. After the adoption of the euro, the dollar’s reserve share dropped back to the low 60%.

So far, this historical data clearly shows that when the dollar’s “gold” status weakened, hyperinflation and hyper interest rates followed, just as the theory predicts. Furthermore, pay attention to the real interest rate column. We benefit tremendously from negative real interest on our ballooning national debt that is increasing by about $1 trillion a year. That will end when the dollar loses its “gold” status. We will have to pay real interest on the money we owe, and we can’t just print paper money since we will already be experiencing hyperinflation. It’s a precipice for the national economy!

What was causing the change in the dollar’s “gold” status? It’s a bit harder to pinpoint, but you can read the following as my informed speculation.

In 1975, the US had lost the Vietnam war, and was no longer perceived as invincible by the rest of the world. By 1978, Japan and Germany began to challenge the US economically, and the Soviet Union kept expanding militarily. Who would want the currency of a country that could be defeated militarily and economically? Thus we saw a drastic reduction of the dollar’s holdings.

But by 1991, the Soviet Union had collapsed, In the same year, the Japanese bubble burst, In one year, the US lost both its military rival and its economic rival, The world began to demand the dollar again. Who doesn’t want the currency of the winner?

As I close my macroeconomics series that includes: 1)The Gold Standard2) The Fiat Money3) The National Saving Shortage4) Is the Dollar the New “Gold”? and this one, 5) What If the Dollar Loses Its “Gold” Status?, I’d like to add one final observation.

What could potentially challenge the dollar’s “gold” status appears to be China. With 4 times the population, growing at 3 times the rate, it already rivals America economically. Michael Pillsbury, author of the bestseller book “The Hundred Year Marathon” and President Trump’s go to China hand, projects that by 2049, China’s economy will be three times the size of the US. If that were to happen, the dollar will almost surely not be able to retain its “gold” status.

That may or may not happen. That’s why I hired someone in China to gather and curate information. He sends me a briefing every day and I read them all. By knowing what’s happening on the ground in China and in the US, and having the right economic and geopolitical framework to interpret this information, I am equipping myself to protect my clients’ wealth and well-being for years to come.

Schedule a free 2nd opinion financial review, buy my wealth management books on Amazon, or download the pdf version here.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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