Why the U.S. Dollar "Works" and Why a Gold-Backed Currency Doesn't

The demise of the dollar as the grease of global trade would trigger global depression, political instability and the end of the Status Quo everywhere. No wonder it's still around.

Yesterday I set up the historical context for understanding "currency wars" and the key role of exporting surplus production in global Capitalism: Currency Wars, Trade and the Consuming Crisis of Capitalism. (See also Marx, Labor's Dwindling Share of the Economy and the Crisis of Advanced Capitalism August 31, 2011.)

The basic dynamic is this:

1. Technology and other efficiencies lead to overproduction and dwindling demand for labor.

2. To keep domestic workers employed and the domestic politics/economy stable, advanced nations must produce a surplus that is sold in some other market. This requires they run structural export/trade surpluses.

3. Since every advanced nation except the U.S. relies on exports to get rid of their surplus production as a means of creating domestic employment and stability, then the U.S. is the sole "importer of last resort" that runs a massive structural trade deficit.

4. To pay for this stupendous inflow of goods and services, the U.S. pays with paper money of its own creation, i.e. the U.S. dollar.

Now imagine how this would work if a global gold-backed currency (GGBC) replaced the dollar overnight. In this scenario, nobody would accept dollars for oil, manufactured goods, etc., and so the U.S. would convert its 8,100 tons of gold into the new GGBC. This would be worth around $500 billion at today's price of gold ($1,900/ounce)--$60 million/ton X 8,100 tons. (Global gold reserves held by central banks.)

Since the U.S. runs a trade deficit of around $600 billion a year, then all the gold held by the U.S. government would be transferred as payment for our imports in less than a year. (Trade deficit $53.1 billion in June U.S. Census Bureau)

After that, the U.S. would have no official gold to pay for imports. Privately held gold could be used to buy foreign goods and materials, but since there is no reliable estimate of privately held gold in the U.S., we can only guess that perhaps there is another year's worth of imports (8,000 tons) available to spend.

Some gold is "consumed" in industrial uses, but more is mined every year as well, so the supply of available gold rises by a relatively modest amount annually: 82 million ounces are mined every year (2,500 metric tons).

The point is that if the U.S. had to pay for its gargantuan imports with gold, it would run out of gold in less than two years. Surplus imports would cease, and the deficit would fall to near-zero: imports would have to equal exports.

The consequence of this reduction of U.S. imports to zero would be catastrophic for the rest of the world, which would collapse into depression. In effect, the final fatal crisis of capitalism--the inevitable results of overproduction, exploitation and the capture of governance by financial capital--would be triggered by the absence of the "importer of last resort," the U.S., soaking up the global surplus.

Oil imports into the U.S. would drop from 9 million barrels a day (BPD) to zero, a decline which would crush the price of oil on the world market, bankrupting the exporters who depend on high prices to fund their domestic stability.

the mercantilist exporters which depend on exports for their growth and/or stability--Germany, Japan, China et al.--would experience an "unvirtuous cycle" of declining production, wages and GDP, a decline triggered by a collapse of exports which would implode the rest of their economies.

The political result would be global instability, revolution, overthrow of governments and a re-ordering of the Status Quo.

By using paper-money dollars, all of this is avoided. That's why the dollar "works" for everyone involved, despite the mewling protests of various players.

It could be argued that the global Status Quo would be conserved if gold doubled in value, but what would drive that price increase if fiat currencies were universally shunned as payment?

Even if gold doubled when priced in dollars, that would only put off the end of imports into the U.S. by a few years.

In sum: global trade and currency flows are incredibly imbalanced, and rebalancing them is impossible without profoundly disruptive structural changes to the global economy. The entire system that every nation depends on is based on the U.S. being the sole "importer of last resort," and the Grand Bargain to sustain domestic employment everywhere but the U.S. requires the U.S. to hold the "reserve currency" which it prints and distributes as payment for the vast flood of others' surpluses.

Get rid of the fiat dollar and you also get rid of structural surpluses exported to the U.S.

Get rid of structural surpluses exported to the U.S. and you end up with global depression and political instability.

That's why the dollar "works" and cannot be replaced, short of replacing the entire global Capitalist economy: "the world's reserve currency" and the ability to absorb the world's surplus production are inseparably bound. Get rid of one and you also get rid of the other. That would spell the end of all export-dependent mercantilist economies.

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Podcast/Interview alerts:

My friend Richard Metzger of the highly popular Dangerous Minds site invited me down to his studio in L.A. for a high-definition (and hopefully illuminating) discussion on THE END OF WORK: AN INTERVIEW WITH CHARLES HUGH SMITH (video). Thanks, Richard! As always, it was great fun and I learned a lot.

Zack Miller of tradestreaming.com was kind enough to interview me recently: check it out if you're interested in investing in troubled times, like now, f'rinstance: Investing In Troubled Times – With Charles Hugh Smith. Thank you, Zack, for the chance to ramble on about my favorite topics.

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