Money and America

Written by Frank Li

America is not only a beautiful country, but also a great country!

One key reason behind America’s greatness, as compared with her two sister countries Canada and Australia, is because America became independent from the British much earlier (What is America, Anyway?).

Unfortunately for America, there appears to be a severe drawback attached to this earlier independence: forgetting, if not a total loss of, history (America’s European Past and Future)! For example, America, the current super-power on earth, is repeating the same mistake made by her predecessor, the Great Britain, with regard to [fiat] money, reserve currency, and the economy …

1. Fiat money

Most currencies today are fiat money, including the U.S. dollar, the British Pound Sterling, and China’s RMB. According to Wikipedia:

Fiat money is money that derives its value from government regulation or law. The term fiat currency is used when the fiat money is used as the main currency of the country. The term derives from the Latin fiat (“let it be done”, “it shall be”).[1]

Fiat money originated in 11th century China,[2] and its use became widespread during the Yuan and Ming dynasties.[3] During the 13th century, Marco Polo described the fiat money of the Yuan Dynasty in his book The Travels of Marco Polo.[4][5] The Nixon Shock of 1971 ended the direct convertibility of the United States dollar to gold. Since then all reserve currencies have been fiat currencies, including the U.S. dollar and the Euro.[6]

2. Reserve currency

Here is a description of reserve currency, according to Wikipedia:

A reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. This permits the issuing country to purchase the commodities at a marginally lower rate than other nations, which must exchange their currencies with each purchase and pay a transaction cost. For major currencies, this transaction cost is negligible with respect to the price of the commodity.

3. Money and economy

Fiat money was invented by the Chinese more than 1,000 years ago, for the purpose of “printing money as the government sees appropriate.” Since then, it has been used, misused, and abused by many governments around the world.

A reserve currency (or “RC”) is earned! Typically, the currency of the country with the strongest economy on earth earns the honor of being the “dominant” RC. Currently, the dominant RC is the U.S. dollar (for less than 100 years so far). Before that, it was the British Pound Sterling (for about 200 years). What is the key behind an RC? Confidence and trust!

Any government can print its own money, any time and in any quantity. When the currency is not an RC (e.g. Ethiopian birr), the impact is limited: domestically of course, as well as to the country’s trading partners. But when the currency is a dominant RC like the U.S. dollar today, the impact of massive money printing is world-wide and huge, with one net result: a loss of confidence and trust in that currency as the dominant RC!

Historically, when a dominant RC is being massively and “irresponsibly” (viewed internationally) printed, it signals the beginning of the end of that currency as a dominant RC. This was what happened to the British Pound Sterling (How the British Pound Sterling Fell from Grace), and this is just what’s happening to the U.S. dollar!

Which currency, then, has been challenging the U.S. dollar? China’s RMB! Here are two pertinent facts:

1. China has already been trading with several nations (e.g. Russia, Venezuela, and several Asian nations) in RMB. Additionally, China recently reached currency agreements with several western countries, including the U.K (U.K., China Reaches Currency Deal), Japan (Currency Agreement for Japan and China), and Australia (Australia, China reach agreement on currency deal).

2. It’s widely recognized that China’s RMB is on the way to becoming a major alternative RC to the U.S. dollar. Here is a recent article: Is the Yuan About to Replace the Dollar as the World’s Reserve Currency? Here is an excerpt:

A country’s rise to economic dominance tends to be accompanied by its currency becoming a reference point, with other currencies tracking it implicitly or explicitly. For a sample comprising emerging market economies, we show that in the last two years, the renminbi (RMB) has increasingly become a reference currency which we define as one which exhibits a high degree of co-movement (CMC) with other currencies. In East Asia, there is already a RMB bloc, because the RMB has become the dominant reference currency, eclipsing the dollar, which is a historic development.

Now, is China’s RMB perfect? No, not at all! China has its own challenges (e.g. China Accounts For Nearly Half Of Worlds New Money Supply). However, the trend is undeniably here: China is well on her way to becoming the #1 economy on earth by 2030, and its RMB will inevitably become a major RC!

4. Money and America

The U.S. dollar is losing its status as the dominant RC! What does that mean to America? Our standard of living will plummet, because we can no longer massively import (yes, America has trade deficits with more than 90 countries) by simply printing more money!

Specifically, petrodollar no more – What a pity!

The U.S. dollar is losing its status as the dominant RC for two main reasons: China’s rise and America’s self-destruction, just as I elaborated in my book (Saving America, Chinese Style) as the reasons behind America’s decline.

How has America been self-destructing? Here is a simple equation Americans must understand about our monetary policy and our economy:

Three notes about America’s prosperity (at least in the past):

1. It has come from the real strength of our economy, not the massive use of steroids!

2. It has come from the real leadership at the top, such as the creation of the petrodollar by President Nixon (Barack Obama vs. Richard Nixon).

3. It has come from capitalism (Top 10 American Misconceptions about Capitalism), not democracy, as we know it today (Top 10 American Misconceptions about Democracy).

Unfortunately for America, all of these “magic” ingredients seem to be gone and elusive today! How can things become so bad? It’s The Political System, Stupid! Here is a concrete example: Senator Obama voted against raising the debt ceiling to $9T in 2006, which he labeled “unpatriotic”. But under President Obama, our national debt has ballooned to almost $17T!

Simply put, QE (Quantitative Easing) is not only irresponsible and additive, but also suicidal! Domestically, it does not solve our real problems (e.g. unemployment). Internationally, it signals the beginning of the end of the U.S. dollar as the dominant RC, and hence the beginning of the end of America, as we know it.

Now, is high unemployment a real domestic problem the Fed has been trying to solve? Yes! Apparently, the scope of the Fed’s job has recently been expanded to explicitly targeting to lower the unemployment rate to 6.5%. What a tragedy! Two points:

1. Unemployment should not be Fed’s job explicitly!

2. The target of 6.5% is possibly obtainable only through the reduction of the participation rate, thanks to our severely flawed method of calculating the unemployment rate. With the economy growing at around 2% in the foreseeable future, we are not even able to accommodate the population growth!

In short, the real unemployment rate will remain high (i.e. above 15%), despite trillions of dollars out of the EQs (QE1, QE2, and QE3)!

Oh yes, Wall Street has been doing very well, thanks to the Fed …

5. Closing

We must change our course, if we are to leave a viable country to our children! For more, read my book: Saving America, Chinese Style.