The Award for the Biggest Threat to the United States Goes To…

People often ask me what I think the biggest threat to our economy is.  I generally answer, “I don’t know,” which is, from most perspectives, true.  We have a number of very big bubbles, such as the stock market (which has entirely too much leveraged money in it – and which, since 2008, reacts more to Federal Reserve policy than to economic fundamentals), our healthcare market (which can’t really consume 20% of our GDP, but does anyway), and our University System (which can’t really make an education cost more than a house, but does anyway).  There are a number of economists who dedicate their lives to the preservation of each new bubble, and many of them, such as Paul Krugman, are at least as smart as they are stupid, so if you ask me to pick which bubble will burst next, frankly – your guess is as good as mine.

As an economist, Paul Krugman is brilliant at finding new, unique ways to create and maintain bubbles, but that is an example of technical proficiency only.  If Paul Krugman were tactically proficient – if he knew how to apply his economic knowledge in the real world – he would instead study how to avoid having bubbles in the first place.  Bubbles pop, and when they do, it’s not some freak accident for Paul Krugman to dissect.  Bubbles pop because that is the nature of bubbles, and all Paul Krugman’s brilliance does is to make it impossible for me to tell you which bubble will burst next, or when it will burst.

What I do know is what will cause the next global depression, and that is the combination of the United States of America’s dollar being the world’s reserve currency, along with the United States’ dollar being a fiat currency.

Toward the end of WWII, the world signed the Bretton Woods Agreement, under which the United States would maintain a gold standard and the rest of the world would peg their currencies to the US dollar (giving them a de facto gold standard as well).  This made us the world’s reserve currency, such that commodities all over the world could be traded in US dollars. 

In 1971, Nixon took us off the gold standard such that today, the value of the dollar is based purely on the willingness of people to accept it.

One of the really cool things about having the world’s reserve currency is that it drives global demand for US dollars, and, in fact, about two-thirds of all US dollars are held overseas.  What that means is that we have created about three times as many dollars as we really need to keep the US economy going – which is fine as long as those dollars stay overseas.  If, on the other hand, we woke up tomorrow and the dollar were no longer the reserve currency, all of those dollars would come back to the United States, and the value of the dollar would drop by about 2/3. The inflation resulting from a plummeting US dollar would throw our entire economy into a period of price discovery, causing a massive recession. 

Thanks to the Federal Reserve, we create money by creating debt, and thanks to our position as the world’s reserve currency, we have to create enough new money every year to prevent deflation, not only at home, but abroad, in the global commodities markets, as well. 

On the taxation side, our government is expected to receive $3.422 trillion next year , and will spend $4.407 trillion.  That’s a difference of almost a trillion dollars, and we get away with that only because our currency is the world’s reserve currency.

China’s economy is the biggest bubble in human history, and not even Paul Krugman is smart enough to keep it from bursting forever.  China is painfully aware that if their currency supplanted ours as the world’s reserve currency, they would have much more room to grow their bubble.  China would LOVE to have the world’s reserve currency. US Deficit spending could, if it were reckless enough, give China the opening they are looking for.

What would the Green New Deal, that Alexandria Ocasio-Cortez is championing, cost?  If you guessed $4.2 trillion a year, you are right.

To fund Alexandria Ocasio-Cortez’s promises (which are also the promises of Bernie Sanders, Elizabeth Warren, and most other prominent Democrats), we would need to raise taxes and/or run deficits to the tune of almost three times our current tax levels.  Democrats are promising to pay for this while also reducing the tax burden on the poor and middle classes.

We could take every penny the rich make, and we would come nowhere near being able to fulfill Democrat promises.  Democrats would be forced to use massive levels of deficit spending – which many of them think is OK (they call this Modern Monetary Theory), and even without massive spending increases, any global recession would reduce demand for US dollars overseas, reducing our ability to run deficits.  This would cause rampant inflation, threatening our standing as the reserve currency.

The biggest threat to the United States, then, is the loss of our status as the world’s reserve currency, which could happen either because we go spend-crazy and over-saturate the global market for US dollars, or because of a bad global recession.

The solution should be to move to a monetary system that does not encourage bubbles, such as the gold standard.  Gold could then become the de facto reserve currency, eliminating the need for the dollar to act in that capacity.  This was the system the world had before Bretton Woods.

I’ve heard it said that we do not have enough gold to go back to a gold standard, but that’s not really true.  As I specified in my article on our money supply, we do not have a fiat system of money, so much as a debt-based system of money.  We have $861 billion in physical currency (which really is fiat), and $109 trillion backed by debt.  If we paid off all of the debt denominated in US dollars, there would only be $861 billion left in existence. 

The US government claims to hold a little over $11 billion in gold, based on the pre-1971 value of $44 an ounce.  Based on the current market price of gold, the US government has gold reserves of $310.5 billion.  We could very easily back $861 billion in physical currency with $310.5 billion in physical gold, and if we wanted to, we could set the exchange rate much lower than today’s market price.  Even if we pegged the dollar to gold at $44 an ounce again, we’d only need $8.6 billion in gold to maintain a 10% fractional level, and we have more than $11 billion in actual gold.  We have plenty of gold.

The amount of debt, on the other hand, might be an issue, and certainly the size of the derivatives market (which is more than ten times the size of the global economy) would be an issue.

If we pegged the dollar to gold at today’s market value of $310.5 dollars per ounce, we could print well over $2 trillion in additional physical currency, and still have a 10% fractional level.  The government, however, owes $22 trillion, $16 trillion of which is in private hands.  If we went on a gold standard, private debt holders would rush to transfer their holdings into gold, and once we ran out of gold, our currency would collapse. 

Our government is, quite literally, too bankrupt for a gold standard to be possible. We have become addicted to debt, and through it, addicted to our status as the world’s reserve currency.  If we lose that status, our economy will collapse, and the rest of the world will follow into a massive global depression.

If we could balance our federal budget, inflation would gradually reduce our federal debt to a manageable level (as a percent of our GDP), and we could then return to a gold standard. The gold standard was imperfect, causing recessions whenever the supply of gold changed too rapidly, but it did prevent runaway deficit spending, and it forced the stock market to react more to actual economic news than to government and Federal Reserve policies. Unfortunately, Medicare spending is only expected to grow as a percent of GDP, for as far as the eye can see, and if we do not reduce our debt load, the question is not one of ‘if’ we will have a massive global depression, but of when that depression will start.

I don’t think Medicare will cause a global depression. I think, rather, that our healthcare spending is a bubble, and that this bubble will eventually either be reduced through a combination of free-market reforms, and tort-law changes, or through a total government takeover of our healthcare system (such as ‘Medicare for All’). Free market reforms would be preferable, as it would make Medicare affordable again, without destroying the quality of our medical care, but either way we will get healthcare spending under control, and then we’ll get a grip on our federal budget.

I also do not think China will cause a global depression. I think, rather, that China will do what Japan has been doing, which is to stagnate. Mercantilism doesn’t work, but it generally does not end in a bang so much as a whimper. I believe China’s growth will come to a dead stop, but I do not foresee collapse.

I, in fact, do not foresee a global depression at all, unless someone like Bernie Sanders, Elizabeth Warren, or Alexandria Ocasio-Cortez becomes President, and resides over a Congress that will enact the kinds of legislation these people want. Their policies would cause rampant inflation, destroying the dollar’s value as the world’s reserve currency, and plunging the world into a depression the likes of which has not been seen since the Fall of Rome. And that is the biggest threat to the United States.