Monday, June 13, 2011

US Dollar Collapse

US Dollar Collapse 1

Is there a looming US dollar collapse? A currency collapse, such as the Soviet Union collapse, has been mentioned as the precursor to a US dollar collapse. But is this a real possibility?

For starters let us state categorically that anyone, including us, that says they can exactly predict things like a US dollar collapse, is probably smoking something that could get them in trouble.

Still - there are many trends happening that have thoughtful people worried. So it might be useful to review what the issues are in a US dollar collapse.

Credit System 101

As a starter, understand that our financial system is built around debt.

Ever since 1971 the U.S. financial has been divorced from any physical standard, such as gold. What we have instead is a Federal Reserve banking system in which money is formed through the issuance of debt. Let me repeat that - money is formed through the issuance of debt.

By issuing debt the Federal Reserve can increase the demand of goods and services. And the more debt there is the more money is printed. This may sound strange to you if you have never studied how it works but in fact through most of the last 35 years or so this system has worked pretty well.

It has worked well because our economic system has steadily grown, and as long as it grows the overall cash flow increases and the average borrower can thus pay that debt back with interest.

But this is where the growing concern about Peak Oil comes in. The growth of this economy, and in fact the growth of the world economy, is believed by many people to have been fueled by the rapidly growing availability of cheap energy from fossil fuels. We have said it before - everything, including people, agriculture, manufacturing, and distribution of goods and services, runs on energy. Cheap energy multiplies the efforts of humans and fuels growth of the economy. There is considerable evidence that every time the cost of energy spikes, whether for political or supply-demand reasons, the economy feels the effect very quickly.

And this is where the concern comes in. When the oil supply cannot keep up with demand, driving up the price and limiting the availability of cheap energy, what happens?

A good argument can be made that in the last few years when oil production seemed to begin to flatten out and prices rose, things begin to happen - the economy stalled, wage growth slowed, unemployment increased, and defaults on debts started. When a significant part of our budget spending goes to underlying energy costs and those energy costs rapidly increase, something has to give. That something we normally call discretionary spending. For the U.S. economy a significant part of spending and economic growth is discretionary.

Maybe a picture would help here. We can show this in a sort of dynamics flow chart:

US Dollar Collapse 2

This is an admittedly over simplistic way of viewing a very complex system. But the basic notion is that the cyclic loop showing that a slow down of growth leads around the loop to less money being spent on all types of goods and services with the result that layoffs put more and more people into a situation in which they cannot pay off their loans and the banks that made too many dubious loans begin to experience more and more loan defaults, which puts them into a condition in which they react by making future loans harder to get, further slowing growth.

The rising cost of energy also hits many companies so hard on the cost side that they begin layoffs independent of declining discretionary spending. What is different now is that trigger outside the loop (peak oil) which starts the slowing growth by removing the thing that has been helping growth all along - cheap and abundant energy. It not only slows growth initially, but that energy effect gets more severe every year.

Why can this be so bad?

There is vastly more debt in our modern financial system than assets to pay them back. If there was not much then we would just let it unwind a bit and clean out a few bad loans, put our house in order, then figure out how to move forward in a bleaker future.

But we cannot get off that easy. We have a long way to fall. And in addition to the obvious debts on loan defaults there are a large number of derivative contracts outstanding, which most of us do not even understand, but we saw what they did to AIG. There are many more shaky ones.

Who is to blame for all this debt?

Government debt, business debt, and personal debt. We have met the enemy and they are us.

There are people who do understand all of this who are very concerned that the worldwide banking system could collapse and that would include a US dollar collapse. And many of them are concerned without even taking peak oil into account, because they are economists and do not consider resource depletion as an important issue.

At some point in this big shell game it will become obvious to all the players that more debt cannot be issued as a stimulus package to get the world out of this problem. At that point things really could begin to unwind because all players will realize it is not possible to pay back their debts and the default lists will balloon, leading to a US dollar collapse.

Alternative Views

It is time to pause and acknowledge that the above view and explanation is not only oversimplified but one that many good people think it just flat wrong. Three countering arguments often come up and can be simply described as follows:

    Peak oil is a myth. We will find more oil with all of the new exploration technology and if not we will replace cheap oil with alternates.

    Cheap energy is not that important to economic growth - many modern businesses rely more on knowledge (or software or something else) and higher energy prices will not slow them down. Only heavy energy intensive industries will suffer if peak oil happens, so a new economy will emerge based on new realities.

    Growth is great but not required for our present system to keep on keeping on.

We obviously disagree with all three counter arguments, particularly the first one. But the global financial - business - agricultural - human system is so complex and interrelated we acknowledge there is room for debate and that debate has to take place. Accordingly we are going to publish alternate views on this site. Not in a forum framework with the accompanying flame wars, but in reasoned articles from all sides.

Articles on the generic subject of economic and financial futures,including US dollar collapse, and a look at other examples, such as the Soviet Union collapse, will appear below. Most of them will be ours and will reflect our biases. But other authors are encourage to write - and we will publish them and acknowledge the authors.