There has been some discussion about the strengthening of the US dollar in the next few years or so. This is mainly driven by the fact that USD is the global reserve currency, and many countries having debt in USD which they need to service. It seems that, while so far mainly economically weak countries have struggled with this and needed to inflate their own currency (e.g. Argentina), in medium term, stronger countries may be affected as well. Combining this with the unstable banking sector in poorer Eurozone countries, it indeed seems that over the next decade, there’s a risk for a wave of defaults across middle class and upper middle class countries across the world due to inability to pay their USD denominated debts.
It is indeed plausible that the Fed and the US government find ways to provide enough liquidity to these countries, but I think there are a few possible scenarios where this doesn’t happen. For one, the political situation in the US doesn’t look very stable and it may be that countries need to default earlier than what would’ve been necessary simply due to incompetence. Second, trade wars, political tensions and ideological differences between the US and various countries in RoW may cause the US to drive countries to default, which may have inadvertent consequences (domino effect). Finally, even if enough US dollar liquidity is provided, in longer term there are several countries which, for various reasons, may still have too high trade deficits to be able to service the US debt (e.g. Spain may be an option, in case the Euro collapses).
So if we, for the rest of this post assume that several countries indeed will default over the coming few years, where does that leave the global economy as a whole? It seems plausible to me that such countries would try to build up new reserves using something that isn’t heavily tilted in the favour of the US. This may be gold, silver, a cryptocurrency such as Bitcoin, or perhaps a cryptocurrency by China (of course heavily depending on how well the Chinese economy, especially its banking sector, will fare over the next decade). After defaulting on the US debt, the US would have little leverage to convince otherwise beyond military power.
If I take this a bit further, I could see China pushing for whatever becomes the new standard in the “defaulted market”, possibly even pressuring countries to adopt this over the US dollar (if they can afford it), simply to reduce the US influence on global economy. If the Eurozone indeed collapses in the next decade, economically relatively strong European countries may find themselves having to choose between the US dollar and the new standard advocated by China and the countries that have defaulted. And the new standard may be something that’s not controlled by China, e.g. gold, so that if China issues an ultimatum — “imports from China only allowed for countries that have no US denominated debt” — then I could see European countries taking China’s side. All of this would cause a large sum of US dollars to flow from RoW to the US, which could cause inflation and an economic crisis in the USA.
Another scenario I could imagine is somewhat milder. As countries get dangerously close to defaulting due to strong US dollar, a plea could be made to devaluate the US dollar — somewhat similarly to the situation near the end of the Bretton Woods system. The US might, contrary to how it responded in the late 60s and early 70s, accept this and take a domestic economy hit for the sake of maintaining the current monetary system (to the extent it can be called one). This would certainly defuse the situation but, on one hand, show that since Bretton Woods, nothing has really improved, and on the other hand, not really improve stability in the long term as another, later danger of a country default wave would set off requests for another devaluation, causing another economy crisis in the US. In the best case, this would buy some time to restructure the global economy to be less dependent on the US dollar overall and ease a transition to a newer system — but as that’s not in the interests of the US, and frankly I can’t imagine the political leadership from anyone to make that happen, I’m somewhat pessimistic that the current “system” coming to its end won’t be pretty. If we manage to delay this course then it could even be several decades until we’re there, but in the worst case any delay will make the eventual transition even worse.
Readers, what holes can you find in my thinking? Please let me know.
References:
On stronger US dollar:
Chinese cryptocurrency: https://asia.nikkei.com/Spotlight/Comment/China-takes-battle-for-cryptocurrency-hegemony-to-new-stage
Chinese banking sector: https://www.scmp.com/comment/opinion/article/3044148/chinas-banking-debt-crisis-ticking-time-bomb-must-be-defused-urgent
On the strength of Eurozone: https://www.dlacalle.com/en/why-the-european-recovery-plan-will-likely-fail/
Spanish trade balance: https://tradingeconomics.com/spain/balance-of-trade