The Collapse of the U.S. Dollar
A Shift in the World Order: Understanding the Causes and Consequences of a Weakening U.S. Dollar
Dear Investors,
This week, our topic of discussion is the continued de-dollarization and its potential impact on the global economy.
Before we delve into the latest developments, let's take a brief trip down memory lane to understand the historical context of the US Dollar.
How did the U.S. Dollar become the world’s reserve currency?
Prior to the US Dollar, the currency of choice for most trade was the British Pound, as the “sun never set on the British empire.”
During World War I, Britain borrowed heavily from the United States to finance its war efforts, which led to a significant increase in the amount of US dollars held in foreign reserves. The US emerged from the war as a major creditor nation, while Britain emerged as a major debtor nation.
Following World War II, with the establishment of the Bretton Woods system in 1944, the US dollar was pegged to gold at a fixed exchange rate, and other countries currencies were pegged to the US dollar. This system provided stability and predictability to international trade and finance, and the US dollar became the dominant currency for international transactions and foreign exchange reserves. Additionally, the US's economic and military power at the time contributed to the widespread adoption of the US dollar as the world's reserve currency.
In 1971, when President Nixon ended the link between the US dollar and gold, the dollar became a currency that could be produced at virtually no cost and without limit.
In order to ensure the continued acceptance of the US dollar as a global currency, a significant new role for the dollar was needed. In 1973, an agreement was struck with Saudi Arabia, the world's largest oil producer at the time. The deal stipulated that Saudi Arabia would sell its oil exclusively in dollars, and in return, the US would guarantee the security of Saudi Arabia, particularly against Iran.
As a result of this agreement, the dollar became the standard currency for buying and selling oil and natural gas worldwide, and this new system became known as the Petro-Dollar Regime. Any leaders, such as Saddam and Gaddafi, who attempted to sell their oil or gas in currencies other than the US dollar faced harsh consequences for themselves and their countries.
In 2018, China took a significant step towards reducing its dependence on the unlimited US dollar by introducing yuan futures oil contracts. With this move, the Chinese government re-established a link between gold and money. Under the new model, China, being the world's largest importer of oil and gas, would use its own currency, the yuan, instead of the US dollar. Meanwhile, sellers such as Iran and Russia were guaranteed to convert their yuan into gold on China's Shanghai Stock Exchange.
Key US Dollar Stats
The US dollar is the most widely used currency in the world, accounting for around 60% of global foreign exchange reserves and 40% of the world's debt.
There are approximately 2.3 trillion US dollars in circulation, with around 80% of these dollars being held outside of the United States.
The US dollar is used as the official currency in several non-US countries, including Panama, Ecuador, and El Salvador.
The US dollar is the currency of choice for international transactions, with around 88% of all foreign exchange transactions involving US dollars.
The US dollar is also a popular currency for central banks to hold as part of their foreign exchange reserves, with the US dollar accounting for over 60% of global central bank reserves.
The US dollar index (DXY), which measures the value of the US dollar against a basket of six major currencies (Euro, Yen, Pound Sterling, Canadian Dollar, Swedish Krona, and Swiss Franc), is a widely watched benchmark for global financial markets.
Looking at the chart of the US Dollar Index (DXY), we can observe that the dollar's strength declined in late 2020 and 2021, coinciding with the period of monetary stimulus in response to the COVID pandemic. Subsequently, following a rapid increase in interest rates, the dollar's strength rebounded, only to decline once again as concerns about de-dollarization began.
What is De-Dollarization?
De-dollarization refers to the process of reducing or eliminating the dominance of the U.S. dollar in the global economy. It can take various forms, such as countries diversifying their foreign exchange reserves away from the dollar, reducing their dependence on dollar-denominated trade and financial transactions, and creating alternative payment systems that bypass the dollar.
The de-dollarization trend has gained momentum in recent years due to a combination of factors, including concerns about the U.S. government's increasing use of economic sanctions as a foreign policy tool, the volatility of the dollar's exchange rate, and the rise of other economic powers such as China and the European Union.
If the dollar were to lose its dominant status, the U.S. could face higher borrowing costs and greater difficulty in financing its deficits.
What is the latest evidence of de-dollarization?
This week, several noteworthy events occurred, including:
China and Brazil reach a deal to settle trades in their own currencies, ditching the US dollar
Brazil, Russia, India, China, and South Africa (BRICS) are in talks of developing a new currency
Chinese yuan surpasses the euro to become Brazil's second-largest currency in foreign reserves
Kenya signed deal with Saudi Arabia and UAE to buy oil with Kenyan shillings instead of US dollars
The Currency Cold War - Is China Leading?
On December 17, 2019, I wrote an article for Forbes aptly named “How China Will Take Over the World.”
A small excerpt:
In the physical world, the U.S. is known for weaponizing its currency, using sanctions (12 countries today and counting) to alter global behavior. But in the digital world, it simultaneously wages war on its own tech companies with regulations, effectively and unwittingly disabling the very tools that could help it achieve lasting global dominance…
China’s answer was not just to ban bitcoin, but to give its people an alternative - the DCEP (Digital Currency Electronic Payment). China becoming the first country to create a central bank backed digital currency shouldn’t come as a surprise. After all, this is a country that has a wider penetration of digital payments than any other region in the world.
WeChat, a popular Chinese chat and peer-to-peer payment app, has surpassed 1 billion users and accounts for 34% of total mobile traffic in China. The app appears to be popular among non-Chinese users as well, particularly in Asia and Africa. Consumers can pay for their every day expenses and make peer-to-peer payments with WeChat. As one of the 5 entities committed to using the DCEP, it is already accepted by most merchants, with paper bills rarely used. Even the homeless proudly display their QR codes in the streets.
China has already penetrated the global market by manufacturing the majority of the world’s consumer products. What happens when it creates the most efficient (and legal) payment system in the world and forces us to use it when buying its goods?
This week Balaji tweeted confirming the trend:
What Does This Mean for Inflation?
De-dollarization can have disastrous effects on US Dollar inflation.
Using the Quantity Theory of Money, rather than CPI, inflation can be measured by:
Inflation rate = (GDP / Money Supply) - 1
To put it simply, if a country's money supply increases at a faster rate than its output, its currency will inflate and lose value. However, as the world's reserve currency, the US has not been subject to this formula. In the US, inflation is measured using CPI, a predetermined basket of goods.
Additionally, as the reserve currency, up to 80% of the US dollar supply is absorbed by foreign trade. But, if this changes, de-dollarization could lead to a sharp devaluation and an increase in inflation. This is because if fewer countries and institutions hold US dollars, its value may decrease in comparison to other currencies, which could lead to higher prices for imported goods and higher inflation in the US.
It's important to note that the current interest rate climate has had a greater recessionary impact on emerging markets, and as a result, some countries may be encouraged to move away from the US dollar and regain control of their monetary sovereignty.
How do we protect our wealth?
During times like this, it is important to take a defensive anti-inflationary strategy and diversify your portfolio away from assets denominated solely in US dollars.
Below are just a few examples of diversification:
Assets denominated in other currencies, such as the euro, yen, or yuan, can help mitigate the impact of a potential devaluation of the US dollar.
Commodities, such as gold, silver, oil, or agricultural products, can provide a hedge against inflation and a weakening dollar.
Real estate, particularly in foreign countries, can provide an opportunity to earn income and accumulate wealth in other currencies.
Foreign stocks, bonds, and other assets can provide diversification and exposure to other currencies and economies.
Gold as a timeless inflation hedge.
Bitcoin as digital gold and an uncorrelated asset.
And as always… #NotFinancialAdvice.
This Week By the Numbers 📈
Michael Saylor’s Microstrategy is the winner of the market this week after announcing they have purchased an additional 6,455 #Bitcoin for approximately $150 million.
Top Stories 🗞️
El Salvador removes all taxes related to tech innovation for economic growth
El Salvador, the first country to establish Bitcoin as a legal tender, has decided to eliminate all taxes on technology innovations. The move runs parallel to establishing the National Bitcoin Office (ONBTC) of El Salvador, also known as “the Bitcoin office.“ When legalizing Bitcoin on Sept. 7, 2021, Salvadoran President Nayib Bukele saw the technology as a means to counter hyperinflation and dependence on the U.S. dollar. Over the past 18 months, El Salvador restrategized Bitcoin investments and utilized capital gains in numerous instances to rebuild the nation. Moving ahead with the strategy, Bukele believed in winding down tax requirements to expedite technological development. As promised, on April 1, Bukele officially sent a bill to Congress — effectively eliminating all income, property, and capital gains taxes on technology innovations “such as software programming, coding, apps and AI development, as well as computing and communications hardware manufacturing.”
Elizabeth Warren is building an anti-crypto army.
Sen. Elizabeth Warren is branding herself as the scourge of crypto. And she’s not doing it alone. The progressive Massachusetts Democrat is starting to recruit conservative Senate Republicans to her anti-crypto cause and getting some early positive vibes from bank lobbyists, who also want to rein in digital asset startups. Warren has emerged as a lead lawmaker on crypto oversight and is trying to build support behind a bill that would have sweeping implications for the industry via tougher anti-money laundering restrictions, including requirements that more crypto service providers verify customer identities. Crypto advocates are resisting Warren’s push, and some dismiss her as an outlier. But her budding partnership with GOP lawmakers reflects broader forces that are poised to unite progressives and conservatives, watchdog groups and bankers, who share common cause in wanting to derail the unfettered growth of crypto.
US regulator sues top crypto exchange Binance, CEO for 'willful evasion'
The world's biggest crypto exchange Binance and its CEO and founder Changpeng Zhao were sued by the U.S. Commodity Futures Trading Commission (CFTC) on Monday for operating what the regulator alleged were an "illegal" exchange and a "sham" compliance program. The CFTC sued Binance, Zhao and its former top compliance executive with "willful evasion" of U.S. law, "while engaging in a calculated strategy of regulatory arbitrage to their commercial benefit." Zhao, a billionaire who was born in China and moved to Canada at the age of 12, called CFTC's complaint as "unexpected and disappointing." The lawsuit comes amid a broader and increasingly high-profile crackdown on crypto companies. For years, U.S. prosecutors and civil investigators have targeted crypto firms for illegal offerings and failures to comply with rules designed to prevent illicit activity. But the pace of such government activity has surged recently.
French prosecutors search major banks in Paris in global tax fraud probe
French authorities searched the Paris offices of five banks Tuesday, including Societe Generale, BNP Paribas and HSBC, on suspicion of fiscal fraud. The search was part of a broad European probe into the dodging of tax payments on dividends. Similar investigations have been conducted in Germany and other European countries. France’s financial prosecution office, the PNF, said in a statement that the probe was linked to so-called “cum-ex” dividend stripping, a trading scheme whereby banks and investors swiftly trade shares of companies around their dividend payout day. The practice aims to blur stock ownership and allow multiple parties to illegally claim tax rebates on dividends. The banks collectively faced a total compensation request of more than $1 billion, including fines and late interest payments.
Donald Trump has been indicted following an investigation into a hush money payment scheme
Former President Donald Trump’s indictment by a New York grand jury has thrust the nation into uncharted political, legal and historical waters, and raised a slew of questions about how the criminal case will unfold. The Manhattan district attorney’s office has been investigating Trump in connection with his alleged role in a hush money payment scheme and cover-up involving adult film star Stormy Daniels that dates to the 2016 presidential election. Though the indictment – which has been filed under seal – has yet to be unveiled, Trump and his allies have already torn into District Attorney Alvin Bragg and the grand jury’s decision, blasting it as “Political Persecution and Election Interference at the highest level in history. Trump faces more than 30 counts related to business fraud in the indictment.
Thank you for reading this week’s edition of the Myth of Money.🚀
Until next week,
Tatiana Koffman
About the Author: Tatiana Koffman
Hi there and thanks for reading! If you stumble upon my newsletter, you will notice that I write about money, economics, and technology. I hold a JD/MBA and spent my career in Capital Markets working across Mergers & Acquisitions, Derivatives, Venture Capital, and Cryptocurrencies. I write to make financial topics more accessible and create equal opportunity for the next generation of investors. I have personally invested in 20+ companies and funds (👉 my portfolio).
This was very well done- a great summary of where we are and where the threats against the dollar being used as the de facto global currency. I haven't exactly worked this out yet--but in the short-term the consequences for the U.S. economy will be terrible. However, in the long-term no longer being the global currency will have benefits to the U.S population. The global currency status helps our international corporations and multinational elites, but it's not clear how much it helps middle class and lower class Americans.
Thanks for the article. I agree that a global financial shift is happening.
Ron Writer