Over the last several weeks there have been rumors that a group of countries, including China, Russia, Japan, France, and the oil rich Gulf States are preparing to dump the dollar for oil trades. This follows months of speculation that many of the same countries have been working to replace the dollar as the world's primary reserve currency with a new international monetary standard based on a basket of currencies. The dollar has been plunging on world markets.
Why is this import? Well, because the massive and ever increasing U.S. government debt has been largely financed by foreign countries. When a country sells us products for dollars, it can use the dollars in four ways:
• It can buy things from us
• It can buy things (like oil) from other counties that are priced in dollars
• It can invest in U.S. assets (stocks, bonds, real estate, etc)
• It can lend the money to the U.S. government to finance deficit spending
Countries like China sell us products for dollars. They lend a lot of this money to the U.S. government to finance deficit spending. China also uses some of the dollars to buy oil, which is priced in dollars. The countries who sell oil for dollars also use their dollars to finance U.S. government debt.
If countries stop taking dollars for oil and other products they sell to us, it will be the end of the U.S. government’s ability to borrow enormous sums of money. If that happens, the days of big government would soon be over because they wouldn’t have the money to keep spending. That’s a very good thing.
The question is how it would happen? If the world dumps the dollar, the government will have two choices. They can cut spending and live within their means. Or they can turn the printing presses on to keep spending just a tiny bit longer, and create a hyperinflation in the process. The latter would be a catastrophe that would wipe out the middle class and set the stage for political upheaval, including the potential for violent revolution. It’s happened in other countries. We don’t need it to happen here.
If the world does dump the dollar, let’s hope that there are enough rational people around to realize that the party is over and have the courage to reign in government spending. If not, things will get much worse before they get better.