Tuesday, November 20, 2012

Why the US Dollar is a Bubble Product

 (Note: this post is in response to this post on Reddit.  The indented and bold text are quotes from that post)

Recently, there has been much talk over a possible collapse of the US dollar, by various means.  In particular, economists have offered predictions, the most notable of which has come from Austrian economists, who generally point out that the US dollar is a fiat currency.  Herein, I delve into that subject.
[don't] Austrian [economists] predict an oncoming, complete collapse of the US dollar?

It is true that some Austrian economists claim that the US dollar will collapse in the near future.  However, most Austrian economists are focused on economic theory, because any prediction without an explanation appears arbitrary to most people.  That is not to say that the majority of Austrian economists are looking to make predictions; rather, they are probably interested in explaining the theories for the sheer sake of educating others in those theories.

Regarding any supposed collapse of the US dollar: a collapse of the US dollar will be preceded by some action, whether on the part of an individual (very unlikely) or by a group of individuals (more likely).  Basically, either the demand for US dollars would have to fall sharply, or the supply of dollars would have to rise sharply.

Now, we must define what the collapse of a currency is: a devaluation of the currency such that it loses its status as a money and begins to be consumed or discarded by those who had previously used it as a currency.  When the Wiemar Republic's currency was devalued through hyperinflation, poor individuals began using that paper money as fuel to keep themselves warm; this is an example of a currency being treated as a commodity.  In Zimbabwe, hyperinflation was so great, that many started looking to gold prospecting as a means of paying for food and other necessities; the Zimbabwean dollars began to be regarding as trivial pieces of paper.

It must be mentioned that a currency collapse does not happen instantly nor evenly.  Some people may try to use the paper notes as currency, thus they are assuming that it has some value left as a currency.  This is so because value is subjective; there is no objective reason that I should trade X units of goods for Y units of currency; each person decides based on the information available to him/her as to how to allocate their scarce resources.  Thus, a currency collapse will affect certain industries to different degrees.  For instance, the financial industry would be hit the hardest, since they trade present dollars for future dollars (and vice-verse),  present goods for future dollars (and vice-verse).  Further, those who trade dollars for other currencies will see their wealth sapped most immediately, thus they will drive the flight from dollars, once the collapse begins.
And wouldn't that likely proceed a massive pullback by the entire world economy?

It certainly true that a major devaluation of the US dollar would lead to a bust in many industries throughout the world.  The US dollar, like all fiat currencies, is the product of a bubble, because it is overvalued through government coercion.  Over the years, the US government, and the state and local governments have been enforcing legal tender laws.  One aspect of legal tender laws is that government-charted organizations, most of all corporations, are required to record and track their finances in US dollars.  This is partly for financial regulation purposes, partly for criminal-investigation purposes (e.g. tracking embezzlement), and partly for tax purposes (e.g. you need to know how much the corporation actually made, so that you can figure out how much to charge it in taxes).

Also, there is the ease of creation of the paper notes.  Because the Federal reserve is not liable for printing the paper money, they are free to print as much as they like.  The issuer of the paper notes makes no promise to exchange anything for the notes.  Instead, the US government promises to force people to use the currency.  On the dollar bills it says, "This note is legal tender for all debts public and private".  This means that the government has unilaterally declared that you and I and everyone else in America are required to use the US dollar to pay for debts if on party to the debt demands it to be so. (Incidentally, this is the second part of legal tender laws.)

Another aspect that contributes to the overvaluation of US dollars is the fact that governments in America requires payments of taxes in US dollars.  (There is an exception regarding gold, but that is a very small issue.)  The IRS says that you must pay X US dollars for Y reason; they do not give you the option to pay in any other currency, such as Euros.  You might say, "why can't a company just operate with some other currency, and make conversions whenever the government requires money or financial information?"  First, the exchange rates are adjusted, based on supply and demand, to make such conversions undesirable.  Further, the price of US dollars in that other currency may fluctuate too greatly, such that the people running the organization may fear that they might lose money by not holding US dollars.  Afterall, the tax code doesn't change very often, whereas currency exchange rates change frequently, at least once per minute.

With large organizations required to use US dollars for their financial accounting, with US dollars being the only taxes, and with the US dollar as officially enforced legal tender, the result is that the US dollar is valued because not using it for finance, paying taxes, or paying debts would result in fines, imprisonment, or some other violence from government.  This bubble is particularly pernicious, because it is even more unavoidable compared to a bubble like the 2000s housing bubble; to avoid usual bubbles, you can merely not trade in the products associated with the industry that is experiencing a bubble.  With the dollar, you can't run a business for very long without using US dollars, whether because everyone is using them or because not doing so would lead to you seeing the force of government.

Thus, the US dollar, like all fiat currencies, is in a perpetual bubble.  The bursting of that bubble could happen just like any other bubble: it will painful and the recovery process will be only as fast as governments do not intervene.  The bust of the Dollar Bubble can be lessened if governments in America were to remove all references to the US dollar from their laws.  Unfortunately, doing so would bring on numerous complications for legislators and bureaucrats.  But, that's another can of worms.

No comments:

Post a Comment