The U.S. May Once Again Be Playing Reserve Currency Chess

TLDR:

1) US national debt and US reserve currency status are intertwined

2) The US and G7’s addiction to deficit spending has reached an uncomfortable level

3) This makes the 20-year decline in foreign purchases of US Debt more likely to continue, with consequences to US dollar demand

4) The recent expiration of the Saudi-US oil purchasing super-structure agreement will significantly drop world demand for the dollar even further

5) Meanwhile, the world’s governments are largely adopting a more open, positive approach to accepting digital currencies, starting with Bitcoin and their own Central bank Digital Currencies (CBDC’s)

6) The US is no stranger to figuratively “horse trading’ or playing chess to maintain the dollar as the world’s reserve currency

7) The US can protect its reserve currency status using a collective basket of factors by promoting private crypto Stablecoins (and not CBDC’s)

Setting the Table for Crypto in a Reserve Currency Discussion

Last week, on June 13, 2024, Blackrock’s CEO Larry Fink reminded the G7 leaders in Italy that their average debt-to-GDP ratio is 129%, and unsurprisingly advocated growth policies that favor private investment in energy infrastructure to get out from under the burdens. The US debt-to-GDP is just under that average at 123% (2023), and Japan is high above it at 263%. Japan is also the number one foreign buyer of US debt. Foreign debt accounts for 24% of the US national debt. In a world where the top developed economies are fiscally far ahead of their skis, one where the US debt of $34.6 Trillion proves the leading economy is highly addicted to deficit spending, one should wonder what the implications to the dollar’s reserve currency status will be of having fewer massive buyers of US debt.

To make matters worse, this question coincides with more news last week about the expiration and non-extension of a 50-year US petrodollar agreement with the Saudis. How will the demand for dollars decrease on the world stage without this quietly manufactured demand super structure?

Finally, the resilience of Bitcoin since it was launched 15 years ago has led many nations to view digital currencies as a viable alternative payment system and/or store of value. Development of CBDC’s (central bank digital currencies) is now happening worldwide, but the US to date has been resistant. Will US CBDC resistance be a negative for its international trade, or is it possible that on par it is an advantage? This post describes why eschewing a CBDC in favor of private versions of Stablecoins is a needed advantage for the US dollar to continue as a reserve currency. The long-term promise or peril of US national debt and reserve currency status may depend on US CBDC policy.

Why Foreign Purchasers Buy US Debt

IF the US is headed toward losing its dollar dominance, nation states are less likely to buy our debt. Here are six reasons why nation states buy 50-75% of US foreign debt primarily through Bonds, Notes and Treasury Bills:

1) It’s thought to be among the world's most secure assets

2) The US government has a timely debt repayment history

3) Portfolio diversification

4) A higher rate of return versus the world’s other government bonds

5) Like-minded geo-political ideologies (in some cases)

6) The dollar has been the widely accepted (reserve) currency in international trade, so legacy and momentum

The seventh, perhaps most fundamental reason for the dollar’s hegemony has been one of supply and demand; carbon-energy producing nations are limited, but energy demand is virtually unlimited. Energy translates into productivity, and in a legal environment designed to promote fair growth, productivity translates to greater opportunities for wealth creation. Wealth translates to economic and military power, and hence, enables the stability inherent in the six bullet points above. It’s self-reinforcing and the reserve currency’s preeminence is dependent on widely acknowledged needed resources for wealth creation, including importantly, petroleum.

Foreign Buyers Are Critical to Maintaining US Debt

As of January 2023, $7.4 Trillion of the debt, about 24%, was owned by foreign entities. The share of all foreign-owned US debt owned by Japan and China dropped from 50% of the total to about 25% over the past 20 years. One of the benefits of owing US debt is that there is always a market for US debt notes. During Covid, China, Brazil and the Saudis already sold large amounts of US Treasuries for short term capital. Given the current geopolitics, and their stated intent to launch a BRICSS-coin, one can reasonably expect at least China and Saudi purchases of US debt to drop even more.

Foreign Purchasing of US Debt is Now Declining, and Why

According to the IMF, the dollar’s share of central bank foreign exchange reserves dropped from over 70% to ~ 55% over about the last 23 years. As the dollar’s hegemony wanes, other countries are designing a sovereign Central Bank Digital Currency (CBDC), and developing a consolidated digital currency (BRICS), but US policy has hesitated to adopt a CBDC policy of its own – why?

A June 13, 2024 Business Insider post stated (QUOTE):

“The IMF's findings are consistent with its previous report in 2022 when it found that the dollar's dominance was waning and getting replaced with alternative currencies.” … “two American think tank analysts wrote in the Financial Times that "American dysfunction" — political and fiscal — is the real threat to dollar dominance. This sentiment was also echoed by Jared Cohen, the president of global affairs at Goldman Sachs, in Foreign Policy.”

If you live in the US, or follow the American scene at all, you do not need to work in a think-tank and have a Nobel Prize in Economics to allow for the adjective ‘dysfunction’ in this case.

Unlike the US, Foreign Buyers of US Debt Will Trade Using CBDC’s

Around 96% of the world’s population and 75% of its GDP are resident outside of the US. If these countries increasingly trade in digital currencies and adopt CBDC’s, it stands to reason that even if the US decides it does not want to generate its own CBDC, its many companies will need to conform with the rest of the world’s trading practices and trade in other countries’ chosen digital currency.

The question then becomes “Which would you rather have grow into the world’s digital reserve currency?

- a BRICSS-coin that is anchored by more authoritarian governments,

- a Euro-coin or UK-coin or other coin run by governmental entities

- your own US CBDC at a time when the world has grown skeptical having been witness to the dysfunction, or

- the world’s only decentralized non-jurisdictional permissionless free-floating currency that has never been hacked; Bitcoin?”

People have deep-seated reservations to any decision, as every action has pros and cons, but for the many who’ve taken the time to understand it I’ll guess that the answer is Bitcoin. If so, how best to engage with the ROW on international trade in Bitcoin, and most likely a multi-chain / multi-coin world including CBDC’s? In the case of the US, the answer that comes to my mind is one step removed; private Stablecoins… but for reasons greater than the many reasons that I’ve read to date. Some history on US reserve currency policy is helpful in framing the discussion.

When It Comes to the US Reserve Currency Status, Past is Prologue

As US Debt to GDP approximates 130%, and the annual Debt service has grown beyond the annual US Defense budget, it becomes more apparent to the world that six of the reserve currency’s seven characteristics are increasingly reliant simply on the US Treasury’s money printer. We need more currency to pay more debt, so we just print it. To quote an old TV commercial, people everywhere are beginning to ask “Where’s the beef?”. Smart policy may still be able to turn this around, and the US is still the most attractive economic powerhouse in the world, but with each passing day the US debt places its currency’s stability in more peril. What can the US do to recover confidence? Let’s step back into history for a moment.

One thing the US can do has already been done three times in the modern era; the US can just re-cast the very definition of money. I’m calling this the Emily Litella “never mind” strategy. While past results are no guarantee of future performance, if it’s been done three times already does it push the logic too far to expect it can be done a fourth time?

In post-war 1940’s, various countries assembled at Bretton Woods, New Hampshire to discuss ways to stem “beggar-thy-neighbor” currency devaluation policies using a “stable-coin”. It was agreed that basing a world currency system on scarce gold as a standard unit of value would be the most effective, and guess who had the most gold? Suddenly, the US dollar became the global reserve currency. The US got away with this.

The Gold-standard outlived its usefulness after the US adopted a “guns and butter” approach to funding the Vietnam War. Basing war expense on deficit spending and money printing without the requisite gold reserves led to inflation. When the French doubted US gold reserves to back the dollar and sent a ship to New York Harbor to demand the gold backing their US currency, President Nixon summarily dropped the gold standard that backed the dollar in favor of a floating currency. (“The Nixon Shock”) While this action was met with consternation overseas, the US got away with it.

Seeking a new backstop for the dollar, one that again would reinforce it as the most attractive currency on the world stage, the US (secretly) forged a petrodollar agreement with the oil-rich Saudi’s; their compensation for only trading Saudi oil in dollars was a US commitment to the Saudi’s defense. Oil’s high universal demand meant that once again, suddenly US dollars were the currency most in demand. As Kissinger noted, “Who controls money can control the world.” So, once again, the US got away with it.

(Note: Using the phrase “got away with it” should mean something different if you are from another country than it does within a US context. A US citizen could just view it as being in the tradition called ‘horse trading’.)

What Now, Without a US Petrodollar Reserve Currency?

Reports this past week are that the 50-year US-Saudi agreement expired, and the Saudi’s chose to forgo an extension. Instead, they have teamed up with Brazil, Russia, India, China and South Africa (BRICS) to develop their own composite “stable-coin”. So, not only has the US dollar lost half of its energy backing, but the Saudi’s are effectively re-orienting their backing to anchor nations with diametrically opposed ideologies. The US is the world’s major oil producer, with the Saudis as number 2 (statements like these should always be qualified with long global trade discussions on crude and sweet), but taking a step back, one must also acknowledge a world that is trending away from carbon-based energy. So, while the value of oil reserves in #2 Saudi and #3 Russia are still the most significant source of support for a new composite digital reserve currency (BRICSS), over time the value of this commodity as a supporting element should wane as well.

Introducing OLEC, The Next Generation OPEC

So, if not gold or oil, what commodity has the requisite properties to be a universal source of value backing a future reserve currency? The answer may be Lithium, which is ironically being called the “new gold”. Just like OPEC was formed to set and manage world oil prices, it is conceivable that an OLEC could be formed with the US in the lead. Of the top 9 lithium producing countries, an Organization of Lithium Exporting Countries (OLEC) could consist of the US plus 6 of the 8 top Lithium producing countries (assuming you disregard China and Brazil who are in BRICS). If climate change impels battery technology into the new energy differentiator, then over time Lithium reserves offer a superior strategic position to a petroleum-backed reserve currency. Two of the top 3 Lithium producers are in South America, and supporting their prosperity could have the ancillary benefit of drawing job-seeking migrants away from US borders in the north to southern countries with more similar cultures where they already speak the language. (Migrants follow jobs, Jobs follow wealth creation) If this were to be the case, it won’t happen overnight. It can start now, but even from my layman’s armchair it will take at least a decade to usurp petroleum as a proper support commodity to legitimize a future reserve currency. Many assert that petroleum independence can only happen with a renewed investment into modern nuclear technology. But again, irrespective of anyone’s personal feelings about nuclear waste, the time to build new nuclear facilities is measured in decades, not years.

Protecting the US Dollar as Reserve Currency Short-Term

Finally, we get down to the reason for this post. Besides Lithium, another commodity that has been called the “new gold” is Bitcoin. Like Gold, Oil, and Lithium, Bitcoin is a limited resource with global economic applicability that is mined, but unlike the former three Bitcoin is mined electronically. (One can successfully argue that as such, it is dependent on electricity so it is a derivative of energy producing material combined with a greater level of intelligence.)

While most of Bitcoin‘s finite supply has already been mined, and much of its supply has been lost, mining new Bitcoin becomes increasingly less productive and more resource intensive over time. This supply-demand programming supports its value accretion. Despite global attempts to hack it in the 15 years since launch, Bitcoin has never been hacked. The centralized on and off ramps to the digital currency known as exchanges and the wallets used to store cryptocurrencies have been successfully targeted however. Bitcoin and cryptocurrencies generally are characterized by very volatile pricing. Rather than go into a long explanation of how it all works, I’ll assume the reader can research it, and I’ll focus on how the very unstable price characteristics of Bitcoin, and other crypto currencies, can actually stabilize the US dollar as a reserve currency.

To CBDC, Or Not To CBDC, That Is The Question

Questions facing the US in 2024 are “What will Stablecoin legislation look like?”, and “Will there be a US CBDC?”. My proposition to the reader is that whereas most countries see the delivery of a sovereign Stablecoin CBDC as a must-have, it may well be against the interests of the US dollar as a reserve currency to present the dollar as a CBDC. Why?

The easy answer is that if surveillance states view CBDC’s as a good thing, it is probably not something the US wants to replicate in order to maintain a free society where privacy rights and property rights are constitutionally sacrosanct. Today, the serial numbers on the bills in your wallet can track the currency, but no one really knows the serial numbers of the bills that are in your particular wallet. Having centralized control of individual units of digital value may mean that a present or future government entity could effectively and remotely make the currency you hold worthless for any reason and by any process they later deem legitimate. It means that you will leave a digital trail for all of your purchases, and all of the currency you possess. In short, it assigns governmental powers that seem anathema to long-standing US values.

If US leaders believe in protecting property and privacy rights, and not exposing its citizens to surveillance, then they would be wise to avoid the “bandwagon effect” beginning to resonate even with our friendly democratic neighbors across the pond. Jumping into a central bank digital currency paradigm just because the majority of countries are doing so only puts the US on an equal footing competitively. When it comes to creating an economic advantage with a reserve currency, the US has shown that it plays chess while others play checkers. But, if the world’s trading is going digital with value-stable CBDC’s, how can the US and its many companies remain in a 1900’s electronic transaction paradigm? This leads us to private Stablecoins.

Today, private Stablecoins play a necessary role in decentralized digital economic systems even though they are managed and centralized pseudo-currencies. As is the case with any important new technology, there have been bumps in the road. Algorithmic-based Stablecoins imploded or were abandoned. Foreign based Stablecoins, notably Tether, got tremendous global traction but rightly or wrongly Tether’s auditing procedures and disclosure have been reported to be suspect when it comes to ensuring the public understands what backs its Stablecoin. A US provider, Circle, has established much closer ties to US and global compliance organizations. While Circle’s disclosures and auditing may be the gold standard for private Stablecoins, after the FTX exchange collapsed, Circle’s USDC coin value decreased to an unsatisfactory level below the US dollar before being revived by quick management action. So, the mechanism for ensuring private Stablecoin value has been effective for the great majority of time, but it is still a work in progress. It probably does not help that despite a ton of lobbying by well-heeled investors, as of June 2024 the US legislation governing its efficacy, operating and reporting models is still undefined.

Crypto Price Instability Leads to National Debt Viability

Private Stablecoins ensure their value by purchasing a mix of largely US dollars complemented by short-term high grade, liquid, government notes and securities to collateralize each coin one for one. This means essentially that a transaction that would require $1 in currency value in a non-crypto digital world now involves $2 in value; one for the currency traded for goods and services, and another for the assets backing the value of the first digital dollar. This seems like an extremely wasteful and inefficient way to create an economy, but in a world of highly volatile crypto prices, short of a CBDC that is backed by the full faith and credit of a government or governments, one-for-one backing with high-grade liquid assets has been the only way designed so far to ensure that a dollar in crypto sent by a taco buyer is still worth a fiat dollar when it is received by the taco seller.

The other key result is that the national entity responsible for the short-term high grade, liquid, government notes and securities used to collateralize transactions in a volatile multi-coin environment gets to have their debt effectively purchased. If your government is the leading productive economy in the world, the chances are that Stablecoins backed by your collateral will be in greatest demand.

Imagine currencies follow virtually everything into a paradigm of digitization. Say it is 2034 and the world has abandoned paper currencies and all purchases are now transacted over blockchains. (I realize this sends shivers up some spines, but play along.) As designed, many people will maintain a healthy stash of currency in Stablecoins in order to transact effectively. The implications are:

a) These Stablecoins first ensure the value on both ends of the transaction.

b) Secondly, they reduce significant Know Your Customer/Anti-Money Laundering (KYC/AML) friction involved when one needs to transfer fiat money into the crypto world in order to transact rapidly.

c) Thirdly, the recent US policy shift to allow both a Bitcoin ETF and an Ethereum ETF practically ensures at least a quarter of the world’s now $100 Trillion GDP will be living in a multi-chain world. Private Stablecoins make transferring one’s value from one digital currency into another digital currency that much easier. (Competing models, such as Polkadot and Cosmos, are being marketed to do this as well.)

Leaving aside the interplay between AI and smart contracts that execute autonomously, these are the primary benefits that private Stablecoins bring to the global digital economy.

For an individual economy acknowledged to be one of the world’s major productive environments, it results in a purchase of its National Debt.

Since private Stablecoins are run by independent or decentralized private organizations, they can be employed without concern for government overreach on privacy and property rights (assuming no back-door government <> private sector dealing).

So, now let’s cover how a private Stablecoin policy also benefits the US dollar’s position as a reserve currency.

Conclusion

We’ve already covered how important foreign debt is to the US economy. We’ve covered how the world’s changing perspective on the strength of the US dollar given:

a) American political and fiscal dysfunction,

b) American economic uncertainty due to the debt, and

c) the increasingly hard sell to get foreign nations to buy American debt in bulk.

In a world with an emerging BRICSS petrodollar, where US deficits will increase as far as the eye can see, there is a strong interdependence between the US currency as a trusted reserve currency on one hand and the ability to trade US debt for foreign currencies on the other. In a world where US debt has also exploded, the dollar’s hegemony is diminished, and a new digital petrodollar is rising, it will be an increasingly hard sell to get foreign governments to buy the US securities, notes and bonds that today comprise about one quarter of US national debt. In this world, the US will need to find a new way to have foreign entities buy its debt.

By transforming every $1 transaction into a $2 transaction, crypto Stablecoins effectively double the value of each transaction. Each extra second dollar is in small part secured by US Treasuries, and other short-term high-grade, liquid US government obligations. Turning a $25 Trillion US economy into a $50 Trillion economy may be a bridge too far, but you get the idea – tacking high-grade collateral onto transactions across a major economy / economies is significant.

The backing for the new reserve currency value would then be derived not from petroleum sales out of Saudi Arabia, but effectively by wholistic US productivity and innovativeness. The basis for the reserve currency goes from the 1940’s gold standard to being the 2020’s gold standard for producing goods and services. This basis encompasses all of the policies, systems and regulatory rigor that are the inner workings of the US economic engine, and it starts with Stablecoins. Can the US maintain its lead in productivity and intellectual capital especially in the face of a rising China and a porous intellectual capital structure? Time will tell, but the combination of a strong position in domestic commodity gold and petroleum reserves plus intellectual capital and productivity within an economic framework enshrined with privacy and property rights, plus military strength, and in the future Lithium through a new OLEC, together makes the dollar the strongest player on the playground regardless of the debt. If people transacting around the world are demanding Stablecoins backed in part by the US economic system, they are in effect buying our debt in order to transact for anything. (As the Modern Monetary Theory folks rejoice.)

What about adopting a CBDC instead? If the US launched its own CBDC Stablecoin, each coin would not need to have the dollar and US security collateralization, because the full faith and credit of the US would already be an inherent backstop. By focusing policy instead on private Stablecoins, the US gets willing buyers of US debt even in the face of significant negative forces on the dollar as a reserve currency. By solving the debt issuance problem with private Stablecoins, the US dollar is in turn strengthened as a reserve currency.

A Final Note

Given the enormous resources at its disposal, and the agility with which it established the dollar as the world’s Reserve Currency on multiple previous occasions, it strains credulity to think that the US government did not anticipate and plan for these National Debt and Reserve Currency issues. Common sense tells me that when it comes to inventing structural economic advantages, the US is still playing chess.

About the Author, Ed Rodriguez

Ed Rodriguez is a sleep-deprived entrepreneur who claims zero expertise in geopolitics, fiscal and monetary policy. Readers have been gifted that acknowledgement for use when they tear up this blog post. The foregoing involves Mr. Rodriguez’ personal opinions, his many assumptions, and the convoluted logic known to have perpetually tortured his friends, so it should not be misconstrued as legal or investment advice, especially since Mr. Rodriguez is not an attorney, your attorney, or an investment advisor. Mr. Rodriguez’ friends wish you to know that anyone using his ideas without conducting their own thorough analysis in order to develop US or other national policy should seek professional counseling. Correcting any inaccuracies adds more to the discussion when done with a collaborative and kind spirit. Unfortunately, Ed’s fragile ego prevents him from engaging in any defense of his theories, but readers are free to fire away amongst themselves. Note: No AI electrons were expended in the writing of this post. If they had, it would likely have resulted in a more compelling set of arguments. Here are a list of sources used to develop this post. Many thanks to those researchers and writers.

https://www.linkedin.com/pulse/my-speech-g7-partnership-global-infrastructure-investment-larry-fink-dbm5e/

https://usafacts.org/articles/which-countries-own-the-most-us-debt/#footnote-1

https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/#:~:text=The%20GDP%20data%20is%20sourced,new%20debt%20data%20is%20available.&text=The%20average%20GDP%20for%20fiscal,GDP%20Ratio%20of%20123%20percent.

https://www.reuters.com/technology/saudi-arabia-joins-bis-led-central-bank-digital-currency-trial-2024-06-05/

https://www.api.org/news-policy-and-issues/blog/2018/06/14/why-the-us-must-import-and-export-oil

https://www.worldometers.info/oil/oil-production-by-country/

https://www.businessinsider.com/dedollarization-imf-stealth-erosion-global-us-dollar-forex-reserves-sanctions-2024-6

https://www.worldometers.info/world-population/us-population/#:~:text=the%20United%20States%20population%20is,96%20people%20per%20mi2).

https://www.worldometers.info/gdp/gdp-by-country/

https://www.nasdaq.com/articles/us-saudi-petrodollar-pact-ends-after-50-years

https://investingnews.com/daily/resource-investing/battery-metals-investing/lithium-investing/lithium-production-by-country/

https://investingnews.com/daily/resource-investing/battery-metals-investing/lithium-investing/lithium-reserves-country/