"Throughout the ages, currencies have ceased to exist because of one rudimentary fact: governments are unable to resist the temptation to create free money for themselves." - Nik Bhatia, Author of Layered Money
Most countries have their own currency that they use within their borders, but the globalized economy runs on the dollar. Over half of all trade deals and international transactions are struck in dollars and nearly every bank holds USD in reserves. Although the United States only makes up 15% of the world economy, its currency is affects everyone, everywhere. If that sounds like a good thing to you—that is shows the power and might and geo-political influence of the US economy—then you're dead wrong. The fact that the dollar is the world's reserve currency is a burden, not a blessing. It's a big part of the reason why the US national debt is climbing, why the US is printing so much money, and why the economy is so unstable. When the world economy is on the brink of collapse, banks everywhere need dollars in order to survive. As the issuer of the world reserve currency, the US has no choice but to take the hit to save the entire global economy, because no one else can.
The United States willingly chose to carry this burden 80 years ago, but it became immediately evident that it was a huge mistake. We’re just now seeing how grave this mistake truly is. The cracks in the system are appearing faster and getting worse. Global financial leaders are calling for a complete economic reset and countries are beginning to hedge their own risk in case the dollar collapses. The world needs a neutral currency that doesn’t burden any one country unfairly, but we’ve been unable to find one that works ever since gold. I propose that the UN issues a new global currency, made for the digital, globalized world, where countries uphold a stake of the currency in proportion to the size of their economies so that the burden of being the world reserve currency can be spread fairly. Call it a central bank for central banks, or perhaps a semi-decentralized central bank. If we don’t act proactively to switch to a neutral digital currency that replaces the international dependency on USD, then the global economy will almost certainly go through history’s biggest economic collapse and the USA could go bankrupt in the process.
The Burden Of The Central Bank
Back in 1944, leaders from around the world met at a hotel in Bretton Woods, New Hampshire to indoctrinate the US Dollar as the single world reserve currency that would run the newly globalized world. As part of the United States' plan to become the unmistakable superpower of the world, all the central banks from every major economy would switch their books to USD. All international trade would be done in USD. All international banking would be done in USD.
This policy was driven by US politicians, not economists, who thought that constantly reminding everyone of the might of the United States was a smart geo-political move. Although problems wouldn't arise for years to come, economists such as Robert Triffin, who conducted research at the Fed and IMF correctly identified that being the world reserve currency would weaken, not strengthen, the country who holds that title.
Almost immediately the Fed lost control of the dollar. US Dollars flooded to Europe after World War II, European banks began issuing credit outside of the the US jurisdiction, and the Fed began losing control over the global supply of credit denominated in USD. Less than three decades after Bretton Woods, the Fed lost complete control and couldn’t keep up with the foreign demand for USD. The Gold Standard broke, the Bretton Woods agreement fell apart, and currencies began free-floating again. Although the Bretton Woods agreement eventually failed, the effect of it is still felt today, because despite the fact that countries use their own local currencies, most of their bank reserves and international trades are still based on the Dollar.
This is why when the US economy is at risk, the global economy is at risk. As someone who invests in Emerging Markets, I’m all too aware of this. Emerging Markets depend on a strong dollar. That’s why a US recession means a global recession. Albeit this dependency is not one sided. If a big global bank, say in Singapore or France, looks like it might default, it could take the Dollar down with it—unless the Fed steps in.
The primary purpose of a central bank is to be the lender of last resort—the big brother bank that saves the smaller private banks when they are in trouble. We saw in the Great Depression what happens when this function falls apart. During the Great Depression, the Gold Standard restricted the Fed from being able to print any more money to lend to private banks. The Fed simply didn't have enough gold in the vaults to issue more dollars. Thus banks didn't have a lender of last resort and in a single year, over 4,000 banks failed.
Instead of letting banks fail en masse, governments have decided that it’s better to print money and take out debt during times of crisis than to let their economies ruin. Governments are totally okay with this when their currency stays within their borders, because they’re taking on a debt now that will be paid back by future tax dollars. What’s not cool is when a foreign bank that operates in a jurisdiction that doesn’t pay taxes is in trouble and needs the US to print money and take out debt in order to keep themselves alive too.
Unfortunately, that’s what has been happening. Over the last decade and a half, the Fed’s policies have turned from Central Bank of the USA to Central Bank of the world—not out of choice, out of necessity. To make matters worse, the Great Depression was merely a loss of trust between consumers and their banks. Individuals were worried that their life savings would dry up if a bank collapsed. We've solved that issue by insuring people's deposits up to $250,000; but what happens when banks lose trust in other banks? There is no insurance policy protecting us against wholesale bank failure (banks with accounts at other banks) and it’s why one big bank failure could rip apart the whole system.
The Sinking Ship
The current financial system works as a hierarchy of banks. The Fed issues new USD reserves to big US banks, big US banks then lend to smaller banks and international banks. Smaller banks and international banks can then lend to each other in what’s known as “money markets”. What this means is that there is a chain of trust in the banking system. Small banks have to trust that the banks they bank with will remain liquid, and those banks trust that their banks remain liquid. If any bank gets a sniff that another bank could default, it could collapse the chain of trust and wipe out most of the world’s wealth overnight—as it almost did in 2008 and again in 2019.
The need for this trust exists because 97% of all the money in the world is credit. It’s not real money, it’s just a debt that anyone can create by writing an IOU, just like a bartender opening up a tab. Banks create credit by simply adjusting the numbers on their bank accounts. That’s why some people call it “pen money”, because it’s made at the tip of the pen. The money on your bar tab doesn’t actually exist, but it allows you to buy beer, then once you pay your tab, the credit disappears. Everyone knows that most of the numbers on their bank account aren’t backed by real money, but nobody cares as long as when they go to the bank, they can withdraw their portion of their funds in the bank.
The 2008 Great Recession was caused because there was way too much bad credit in the system. Banks started to default and the chain of trust was broken. The only way to restore the chain of trust was for the Fed to print money and take out national debt, but what’s interesting is where that new money went.
On August 9, 2007 a bank in France grew skeptical of derivatives related to American home borrowers and froze all cash withdrawals for funds associated with them. This created panic and could have forced a run up the chain to larger banks as all the banks tried to secure their Dollar holdings. Had this happened, it would have resulted in a massive run on all the big US banks, creating a global financial system collapse. Why? Because a bank in FRANCE froze up with fear.
There's an important lesson here. The US dollar is so widely traded that there are now cracks emerging in the system all over the world that are outside of the US governments control, yet if the US government doesn't provide a lifeline to these international banks then, banks in London, France, Singapore, Hong Kong, Japan, etc, could take down the entire US banking system down with it. So what did the Fed do? They had no choice but to give foreign banks a lifeline via forex swaps, to help foreign central banks out who were illiquid.
Again on September 17, 2019, there was a single day of illiquidity in money markets. Remember that money markets is how banks lend to each other. There are multiple types of money markets. One of them is known as the Treasury Repo market (where banks stake treasury bonds as collateral to borrow money from one another) and on this day, the Treasury Repo interest rate spiked by 8%. This never happens, it normally stays congruent to the rate that banks can borrow from the Fed at (2% right now), so the fact that the interest rate drifted was a huge deal. It means that on that day at least one bank couldn’t find any other banks with extra cash laying around that they were willing to lend out. It was a leading indicator that banks everywhere were on the brink of becoming illiquid. Within hours, the Fed reacted with a new lifeline; they created a new form of credit for the Treasury Repo Market, so any bank in the world with Treasury Bonds to stake as collateral could borrow directly from the Fed. The Fed is no longer the central bank of the United States, it’s the central bank of the world.
When the pandemic hit a few months later, the Fed used this excuse to open up new lines of credit for foreign banks and to pump banks full of credit so that we could have a few more years of economic growth before we have to deal with the fact that we still have tons of bad debt floating around in the economy due to the actions that led up to 2008. In theory, we could keep kicking the problem down the road by printing money and bumping up the national debt, which now exceeds $26.95 Trillion. This is the burden that United States taxpayers have to bear to keep the world economy afloat.
But in practice, this won’t work, because the whole system depends on trust. People trust the Dollar because they think that the United States won’t go bankrupt, but the national debt has a ceiling; it can’t keep growing forever. And if we don’t take out debt the only alternative we have is to print money, in which case history is full of examples where governments have debased their currency to the point where people lose trust in it and stop using it altogether. The way I see it, currency reform is inevitable, the question is “Are we going to proactively come up with a solution or will we be forced into one by a global economic collapse?”
A Solution That's Not Ready Yet
Every year, financial leaders from around the world get together in Jackson Hole, Wyoming to discuss the state of the world economy. In recent years representatives from the Bank of England and European Central Bank have been calling for a world currency reset to undo the mistake created in 1944 at Bretton Woods. The idea of being the world reserve currency was once a geo-political ideology, but it has now become an economic burden beyond repair. The US Fed doesn’t want the burden anymore but neither does anyone else. I believe that cryptocurrency could provide the solution that the world needs in the new digital, globalized, economy.
A cryptocurrency issued by the UN would allow for a world reserve currency that spreads the burden of being the lender of last resort across all countries equally by using Proof-Of-Stake as the mining technique. All countries would have a fair vote regarding monetary policy; no countries would be excluded from the world economy and no countries would single-handedly bear the burden of lender of last resort. It would also fix a global financial system that is stupid, wasteful, and unfair. The countries that issue the world reserve currencies could be jeopardized by foreign banks that don't follow their laws and the poor countries who need reserve currencies the most are being excluded from the global financial system. All international transactions today are done digitally anyways. It only makes sense that we switch to a new digital currency built for the globalized world. There’s no reason why we should be running transactions through clearing banks that slow down the economy and cost (mostly poor people) a lot of money.
This is an excellent solution to the age-old problem of needing a neutral currency, but we're not there yet--technologically or politically. Blockchain technology is getting close, but it needs further development before it can handle such a global project. We also need nations on board. We could start with just the current world reserve currency leaders, the USA, Britain, and the EU, but I fear that getting these parties to collaborate will be more difficult than building the platform. Furthermore, getting them to collaborate proactively, without an immediate threat, is even more unlikely.
A new Bretton Woods agreement is imminent. The USA can’t serve as the lender of last resort for the world economy forever. It will either make the USA poor, collapse the currency, or both. Things may seem fine right now because our economy is artificially hoisted up by fresh credit, but do not let the calm before the storm convince you that this issue is not urgent. It needs to be addressed now, before a new crack in the world economy appears that the Fed can’t repair in time.
