How A Country Loses Its Currency Reserve Status

How A Country Loses Its Currency Reserve Status

The U.S. dollar enjoys the world reserve currency status due to numerous factors. Legal and investor security, an open and transparent market, as well as independent institutions with checks and balances that limit political power and strengthen the country’s currency in relative terms. No, a country does not have a world reserve currency due to military power. No one accepted the kopek when the Soviet Union ruled half the world. For a fiat currency to be a world reserve it needs to be widely accepted as unit of measure, method of payment and reserve of value.

The problem is that all the above may be under threat.

Increasing pressure from politicians is threatening the reserve of value status of fiat currencies, and the political threat is not only against monetary authorities, but aimed at all institutions that provide independent checks and balances that limit political imposition.

When politicians talk about the “social use” of money, what they are basically saying you will suffer higher inflation for longer. It means using the currency to disguise massive fiscal imbalances under the illusion that citizens will always have to use the local currency. It makes no sense. A fiat currency, like any other good or service, is subject to supply and demand. Excessive supply is damaging its purchasing power the same way that excessive supply lowers the price of a good, but weakening demand added to rising supply leads to the collapse of the currency.

The moment that politicians stop defending the reserve of value status of their currency they are destroying the country they promise to defend.

Destroying the currency is the first sign of the decline of a nation. The rulers of the state never think that it will end because the process is slow until it suddenly accelerates with hyperinflation and the state crumbles. This happens when neither domestic nor foreign citizens will accept the state currency as a means of payment and reserve of value. It erodes slowly and the collapse happens fast.

Countries lose their currency demand when governments attack the reserve of value status and the independence of its institutions under the perception that nothing will change. Assessing the patience of foreign and domestic users of a currency always ends badly. However, political powers believe that they can always issue a devalued currency to hostage citizens that can only use the credit note issued by the state. It is false. When domestic citizens lose their patience with an increasingly worthless currency they move on to other systems of trade, using other means of payment and even barter.

In fact, most politicians believe that if “nothing” has happened so far and the country’s currency remains widely used then they can continue eroding the independence of institutions and the currency’s purchasing power forever. It is incorrect, and all empires have vanished under this illusion. The illusion of monetary sovereignty.

This is why MMT -modern monetary theory- is so wrong. It assumes that monetary sovereignty is static and gives the right to governments to mismanage money at their will. And monetary sovereignty vanishes as quickly as the fallacy of endless money printing.

The U.S dollar remains the world reserve currency because, so far, it has no contenders. This is not because the Federal Reserve policies are sound money, but because others are worse. The U.S. government and the Federal Reserve should know that imposing the use of a currency through digital currencies is not the answer. The only way in which the U.S. dollar will remain a world reserve currency is if the government and the Fed commit to strengthening its reserve status by increasing popular and global demand, not imposing it, because it never works.

Alternatives seem to be few or none until someone offers a true reserve of value with demonstrable demand driven by independent institutions. The Federal government and the central bank may believe that there is no contender today because other fiat currencies are worse, and they are right in that analysis. The problem is that alternatives may come from truly independent means. So far, the Fed has been smart enough to point at the Achilles’ heel of cryptocurrencies: Liquidity. However, regardless of the weakness of the currently available alternatives, the only thing that will strengthen a fiat currency is to be a reserve of value. If the Fed and the U.S. government ignore reserve of value as a policy, the end of the United States global status will be closer.

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

4 thoughts on “How A Country Loses Its Currency Reserve Status

  1. We all know that gold fits the criteria and that all fiat currencies have lost value against gold over time. And gold is perfect for the crypto world. Take the algorithms and use ownership to a weight of gold as what they protect. I use my card to transfer ownership of physical from my account to the seller’s, and my employer or customer transfers ownership of gold from their account. The clearing mechanism can be audited fairly simply and no faith is something imaginary is needed.

  2. Thanks for your thoughts. I don’t disagree with them. Yes, here comes the “but” part.
    While you touched on crypto you did not bring the elephant in the room to the piece.
    That would be BRICS and how it is gaining support beyond the 5. Should the Yuan
    become the currency for “their” economies, the US dollar will suffer drastically and
    our supply chains will collapse. Again, I like your thoughts. Just my .02

  3. A digital dollar would give the government utmost control of every aspect of our lives. What most people forget, or at least neglect, is the degree of freedom a physical dollar provides. Personally I think the day will come when the physical dollar will end. It only makes sense and there are a plethora of arguments to support it. Unfortunately those benefits will mean that freedom will suffer and likely die. The tangible ability to maintain a physical means of trade will become transferred to multiple ways of barter.

    In my mind I have an image that resembles a Mad Max scenario with the local flea market on steroids where useful and consumable items are traded for other useful and consumable items or other measurable and tangible items such as physical gold coins, Goldback bills, junk silver, or even ammunition if it’s not outlawed.

    Bottom line, if the federal reserve note is removed from circulation, privacy will be dead and every aspect of your life can be controlled. Lastly, BRICS will be a huge challenge to the federal reserve hegemony and will likely push the US towards a digital dollar. Somehow I feel that the government wants our currency to be debased anyway.

  4. Ironically, the Biden Administration’s battle against fossil fuel energy is going to damage the petrodollar. The politicians have to know this. A solid alternative to the dollar—a currency backed by commodities, including precious metals—is what BRICS nations are building toward—especially since those countries are loading up on gold and silver. In the meantime Western nations, led by the US, are consumed with culture politics, a Climate God, and paper currency. Who has their eyes on the ball?

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