Yesterday in Money Morning, I showed you just how easily we could slip toward a crisis of confidence in the US dollar.
I explained how the crisis will likely begin in the currency markets…spreading quickly to stocks, bonds and commodities. When the dollar collapses, the dollar-denominated markets will collapse too. Panic will quickly spread throughout the world.
It will catch the US Federal Reserve on the hop. Right now, the Fed is hoping for the best and quite unprepared for the worst.
So how bad could that worst-case scenario get?
On a knife-edge
There is a very real danger that the Fed’s money printing could suddenly morph into hyperinflation. Even if inflation does not affect consumer prices, it can show up in asset prices leading to bubbles in stocks, commodities, land and other hard assets. These bubbles are prone to burst — like tech stocks in 2000, or US housing in 2007.
The Fed claims to have the tools needed to avert these outcomes. But no central bank has ever tried those tools in this setting or on such a large scale.
The Fed’s remedies — higher rates and tight money — are likely to lead straight to the kind of depression the Fed set out to avoid in the first place.
The US economy is resting on a knife-edge between depression and hyperinflation. Millions of investors, business owners and workers wonder how much longer the Fed can balance the knife.
Worse yet, none of this happens in a vacuum. If the Fed limited its policy meddling to the US economy, that would be one thing…but they are not.
The effects of printing US dollars are global. By engaging in extreme money printing, the Fed has effectively declared currency war on the world.
Many of the feared effects of Fed policy in the US are already appearing overseas. Printing dollars at home means higher inflation in China…higher food prices in Egypt…and stock bubbles in Brazil.
Printing money devalues US debt so foreign creditors get paid back in cheaper dollars. That leads to worse unemployment in developing economies as their exports become more expensive for Americans.
The resulting inflation also drives higher prices for the inputs developing economies need — like copper, corn, oil and wheat. Foreign countries have begun to fight back against US-caused inflation through subsidies, tariffs and capital controls. The currency war is expanding fast.
While Fed money printing on a trillion-dollar scale may be new, currency wars are not. Currency wars have been fought before — twice in the twentieth century alone — and they always end badly.
At best, currency wars offer the sorry spectacle of countries stealing growth from trading partners. At worst, they degenerate into bouts of inflation, recession, retaliation and actual violence. The scramble for resources leads to invasion and war.
The historical precedents are sobering enough. But the dangers today are even greater, turbocharged by the scale and complexity of financial linkages throughout the world.
What baffles many observers is the dismal failure of economists to foresee or prevent the financial catastrophes of recent years. Not only have their theories failed to prevent calamity, they are making the currency wars worse.
The economists’ latest solutions — such as the global currency called the special drawing right (SDR) — present hidden new dangers while resolving none of the current dilemmas.
Among the new dangers are threats not just to America’s economic well-being but to its national security as well.
As national security experts examine currency issues traditionally left to the Treasury, new threats continually come into focus…from covert gold purchases by China, to the hidden agendas of sovereign wealth funds.
Greater than any single threat is the ultimate danger of the collapse of the dollar itself.
Senior military and intelligence officials have now come to the realisation that America can only maintain its unique military predominance with an equally unique and predominant role for the dollar. If the US dollar falls, America’s national security falls with it.
The outcome of the current currency war is not yet certain. But some version of the worst-case scenario is almost inevitable if US and world economic leaders fail to learn from the mistakes of their predecessors.
Contributing Editor, Money Morning
James G. Rickards is the editor of Strategic Intelligence, the newest newsletter from Agora Financial. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.