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The Dollar is Too Big to Fail

By Isaac Adlerstein '21, Staff Writer

· Isaac Adlerstein

Amid the bloodiest war in human history, the global economic system was reshaped like never before. The Bretton Woods agreement, although reached in 1944, is still relevant today. Unless the United States is able to bring its gargantuan national debt under control, the world may see economic crisis greater than 1929 and 2008.

At the time the Bretton Woods agreement was signed, the United States was the world’s sole superpower and one of the few countries whose economy had not been obliterated by the war. With the war coming to an end and with near certainty that the United States and its allies would emerge victorious, the post-war global order became a major focus to many of the the world’s major players.

730 delegates from 44 allied countries convened in Bretton Woods, New Hampshire, and began negotiating what the international economic system would look like. The conference created the International Monetary Fund and a new system of global monetary exchange. Under this new system of exchange, each signatory nation’s currency would have its value tied to the United States Dollar, and the dollar would have its value tied to gold at a rate of $35 per ounce. This linked the stability of the global economic system upon the stability of the United States dollar.

In the following years, Europe recovered from the war, and the global economy expanded like it never had before. The system was working well.

However, things began to change in the late 1960s. With the United States embroiled in Vietnam, a nuclear, chemical, and biological arms race, and creating costly social welfare programs like Medicare and Medicaid, the Europeans became skeptical that the United States was spending more dollars than it possessed in gold. Countries began asking for their gold back.

If an all-out run was made on the United States gold reserves, the value of the dollar would collapse and bring down the United States economy with it.

This fear triggered President Richard Nixon to pull the United States out of the Bretton Woods system, and “temporarily” suspended the convertibility of the dollar into gold. Fast-forward to 2018, and that temporary suspension from August 14, 1971 still stands.

What the “Nixon Shock” did was create a global fiat economy. Because currencies are backed by nothing, and thus are just paper, they only have value because they are assigned value. Without that value assigned to them, they are just worthless paper. Thus, with nothing but declared value backing them, countries could inflate or deflate their values as much as they please. This could be done by simply putting in or taking out money from circulation.

This new dynamic gave the United States and all the other countries in the world more flexibility when creating fiscal and monetary policy. Added control over inflation allowed countries to devalue their currencies to make them more appealing trade partners, stimulate the economy or pay debts by putting more money into circulation, and adjust interest rates with less oversight.

All of these tools can be used for good if those who control them exercise restraint. However, restraint can be a difficult thing to find when throwing money at problems is seemingly always an easy solution.

From 1971 to 2017, inflation in the United States increased 505.23% [1]. Part of this was the natural result of a growing population, but most of it was due to increased government spending and debt.

In 1945, United States debt was roughly $260 billion, which, adjusted to inflation, is the equivalent of $3.5 trillion [2]. In 1971, debt was roughly $400 billion, which, adjusted to inflation, is the equivalent of $2.4 trillion today [2]. Somehow, in 2018, the national debt is $21.6 trillion [3].

Foreign nations own about $6.3 trillion of that debt, which alone would be incredibly problematic. But the United States owes the other $15.3 trillion to itself—to its future.

When the United States government needs to borrow money, it sells bonds to individuals, businesses, government agencies, and foreign nations. The reason why the bonds are able to sell so easily is because the United States has never defaulted on its debt. A guaranteed return on investment makes the dollar the most stable currency in the world. Thus, 60% of the world’s financial reserves are still in dollars [4].

But what would happen if the United States were no longer able to sell more bonds, and were forced to stop pushing off the day that it has to address its debt? The government would be confronted with two options: either print more money or default.

Countries have tried the former before, and have learned the hard way that doing so is a horrible idea. Flashback to Zimbabwe in 2009, when it hyperinflated its currency to a mind-boggling 89.7 Sextillion (1021) percent [5]. The government issued 100 trillion dollar bank notes. At one point, the conversion rate was 758,300,000,000 Zimbabwean dollars per United States dollar [6].

With the latter, the government would be unable to pay its bills. Social security, healthcare, defense, infrastructure, and several other government obligations would not be met. United States government bond owners would not be remunerated. The United States would default for the first time in its history and its credit rating would plummet.

Both cases result in the same tragic outcome: the collapse of the value of the dollar.

This is why Congress keeps raising the debt ceiling, which puts a limit on how much money the government can borrow. But the more Congress borrows now, the more it will have to pay later. Unless the government magically breaks its gridlock and is somehow able to find decades of multi-hundred-billion-dollar budget surpluses, it will have to continue raising the debt ceiling until the end of time.

Recognizing this, why then do foreign governments continue to buy United States government bonds? The reason why: the dollar is too big to fail.

As mentioned before, 60% of the world’s currency reserves are in the form of the dollar. If the dollar were to collapse, those nations would absorb huge losses themselves. This is why China continues playing the game: it is buying itself time to become less dependent on the value of the dollar, and slowly make the Yuan the world’s reserve currency.

To nearly all nations on earth, the United States is a major trading partner. If the United States economy were to suddenly descend into crisis, the world would lose its biggest trade partner and market, and quickly descend into economic crisis itself.

It is possible that these potential scenarios may turn into realities not too far down the road. Eventually the debt will reach a point where it cannot be addressed. The United States will no longer be able to borrow from itself or from other countries—the world will have moved away from the dollar, and the United States economy will no longer be too big to fail.

Unless the debt gets brought under control, economic collapse is coming. The American people will recover like they have in the past, but the United States’ economic power and the status-quo of the global monetary system will likely not.

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