Submitted by Charles Hugh Smith from Of Two Minds
Why the U.S. Dollar Is Not Going to Zero Anytime Soon
The conventional view looks at the domestic credit bubble, the trillions in derivatives and the phantom assets propping the whole mess up and concludes that the only way out is to print the U.S. dollar into oblivion, i.e. create enough dollars that the debts can be paid but in doing so, depreciate the dollar's purchasing power to near-zero.
This process of extravagant creation of paper money is also called hyper-inflation.
While it is compelling to see hyper-inflation as the only way out in terms of the domestic credit/leverage bubble, the dollar has an entirely different dynamic if we look at foreign exchange (FX) and foreign trade.
Many analysts fixate on monetary policy as if it and the relationship of gold to the dollar are the foundation of our problems. These analysts often pinpoint the 1971 decision by President Nixon to abandon the gold standard as the start of our troubles. That decision certainly had a number of consequences, but 80% the dollar's loss of purchasing power occurred before the abandonment of dollar convertibility to gold.
The depreciation from 1971 on looks rather modest on this chart. Clearly, dropping the convertibility of the dollar to gold did not change the overall depreciation dynamic much; the dollar had been losing purchasing power since the turn of the century.
Here is the dollar's purchasing power plotted by another source. Note how the purchasing power fluctuated significantly in the 19th century. The emergence of the (privately owned) Federal Reserve as the issuer of the dollar accelerated the dollar's depreciation--a decline interrupted only by the deflationary Great Depression.
To understand the dollar's primary role as a means of exchange for trade, let's start with the relative size of the foreign exchange market. The FX markets trade some $2 trillion a day, far larger than either the credit or stock markets.
Fiat currency is the ultimate phantom asset. It is quite miraculous when you think about it. We print some symbols and images on a piece of paper, and we can exchange that intrinsically worthless paper for real goods and materials: oil, electronics, vehicles, and so on. That magic privilege is certainly worth maintaining.
So why would anyone trade real tangible wealth (say, oil) for specially printed paper? There are basically three reasons:
1. They can use the paper to buy goods and services from other nations.
2. They can buy bonds with the paper money that will draw interest and be paid as promised.
3. When the money is withdrawn to exchange for goods and services, it has retained the vast majority of the purchasing power it held when deposited.
If we look at the charts above, we might wonder why anyone would accept U.S. dollars (USD) as payment for real goods when it so steadily loses purchasing power. The answer can be found by re-reading the three conditions above: if the USD draw interest, and that income is larger than the loss of purchasing power, then the money will still retain its purchasing power when withdrawn.
For instance, if the USD deposits draw 5% annual interest and the USD loses 3% of purchasing power every year, the owner of the dollar still earned a 2% positive return.
There is another interesting feature of interest-bearing bonds: as interest rates decline, the bond rises in value. This sets up the delicious irony of the Chinese whining about their $1 trillion in U.S. Treasury bonds earning such low yields, while in fact their holdings have greatly increased in value as interest rates have declined.
But what underpins a fiat currency's purchasing power? Ultimately, the value of any paper (free-floating) currency is based on the issuer's ability to enforce claims on reliably stable income streams and assets.
Any nation that promises to pay interest on bonds denominated in its currency must be able to enforce its claim on the national income via taxation. If the national income is too unreliable or unstable to support the claim, the international community loses faith in the currency and it depreciates to zero even if the currency isn't printed with abandon.
In other words, the value of the currency as an international means of exchange is not just a function of monetary policy or money supply; the market "prices" a free-floating currency on a number of factors, all related to the three above points.
Read more>> Guest Post: Why the U.S. Dollar Is Not Going to Zero Anytime Soon | ZeroHedge
Why the U.S. Dollar Is Not Going to Zero Anytime Soon
The market considers a variety of inputs in pricing the value of a
floating currency. The dollar has more going for it than is generally
understood.
The conventional view looks at the domestic credit bubble, the trillions in derivatives and the phantom assets propping the whole mess up and concludes that the only way out is to print the U.S. dollar into oblivion, i.e. create enough dollars that the debts can be paid but in doing so, depreciate the dollar's purchasing power to near-zero.
This process of extravagant creation of paper money is also called hyper-inflation.
While it is compelling to see hyper-inflation as the only way out in terms of the domestic credit/leverage bubble, the dollar has an entirely different dynamic if we look at foreign exchange (FX) and foreign trade.
Many analysts fixate on monetary policy as if it and the relationship of gold to the dollar are the foundation of our problems. These analysts often pinpoint the 1971 decision by President Nixon to abandon the gold standard as the start of our troubles. That decision certainly had a number of consequences, but 80% the dollar's loss of purchasing power occurred before the abandonment of dollar convertibility to gold.
The depreciation from 1971 on looks rather modest on this chart. Clearly, dropping the convertibility of the dollar to gold did not change the overall depreciation dynamic much; the dollar had been losing purchasing power since the turn of the century.
Here is the dollar's purchasing power plotted by another source. Note how the purchasing power fluctuated significantly in the 19th century. The emergence of the (privately owned) Federal Reserve as the issuer of the dollar accelerated the dollar's depreciation--a decline interrupted only by the deflationary Great Depression.
To understand the dollar's primary role as a means of exchange for trade, let's start with the relative size of the foreign exchange market. The FX markets trade some $2 trillion a day, far larger than either the credit or stock markets.
Fiat currency is the ultimate phantom asset. It is quite miraculous when you think about it. We print some symbols and images on a piece of paper, and we can exchange that intrinsically worthless paper for real goods and materials: oil, electronics, vehicles, and so on. That magic privilege is certainly worth maintaining.
So why would anyone trade real tangible wealth (say, oil) for specially printed paper? There are basically three reasons:
1. They can use the paper to buy goods and services from other nations.
2. They can buy bonds with the paper money that will draw interest and be paid as promised.
3. When the money is withdrawn to exchange for goods and services, it has retained the vast majority of the purchasing power it held when deposited.
If we look at the charts above, we might wonder why anyone would accept U.S. dollars (USD) as payment for real goods when it so steadily loses purchasing power. The answer can be found by re-reading the three conditions above: if the USD draw interest, and that income is larger than the loss of purchasing power, then the money will still retain its purchasing power when withdrawn.
For instance, if the USD deposits draw 5% annual interest and the USD loses 3% of purchasing power every year, the owner of the dollar still earned a 2% positive return.
There is another interesting feature of interest-bearing bonds: as interest rates decline, the bond rises in value. This sets up the delicious irony of the Chinese whining about their $1 trillion in U.S. Treasury bonds earning such low yields, while in fact their holdings have greatly increased in value as interest rates have declined.
But what underpins a fiat currency's purchasing power? Ultimately, the value of any paper (free-floating) currency is based on the issuer's ability to enforce claims on reliably stable income streams and assets.
Any nation that promises to pay interest on bonds denominated in its currency must be able to enforce its claim on the national income via taxation. If the national income is too unreliable or unstable to support the claim, the international community loses faith in the currency and it depreciates to zero even if the currency isn't printed with abandon.
In other words, the value of the currency as an international means of exchange is not just a function of monetary policy or money supply; the market "prices" a free-floating currency on a number of factors, all related to the three above points.
Read more>> Guest Post: Why the U.S. Dollar Is Not Going to Zero Anytime Soon | ZeroHedge
