Conclusion
The path of the dollar is unsustainable and therefore the dollar will not be sustained. In time, the dollar will join a crowd of multiple reserve currencies, be subordinated to SDRs, be rejuvenated by gold or descend into chaos with both redemptive and terminal possibilities. Of these four outcomes, the use of multiple reserve currencies seems least likely because it solves none of the problems of debt and deficits, but merely moves the problem around from country to country in a continuation of the classic currency war. The SDR solution is being promoted by some global elites in the G20 finance ministries and IMF executive suites, yet to the extent that it simply replaces national paper currencies with a global paper currency, it risks its own rejection and instability in time. A studied, expertly implemented return to the gold standard offers the best chance of stability but commands so little academic respect as to be a nonstarter in current debates. This leaves chaos as a strong possibility. Within chaos, however, there is a second chance to go for gold, albeit in a sudden, unstudied way. Finally, there is just chaos, followed by something worse.
The collapse of the dollar might be a particularly trying catastrophe of its own or occur as part of an even larger collapse of civilization. It might merely mark a turning away from the excesses of paper money or be a milepost on the way to a maelstrom. None of this is inevitable, yet all of it is possible.
It is not too late to step back from the brink of catastrophic collapse. Complexity starts out as a friend and ends up the enemy. Once complexity and large scale are seen to be the danger, the solution is a mixture of descaling, compartmentalization and simplification. This is why a ship whose hold is broken up by bulkheads is less likely to sink than a vessel with a single large hold. This is why forest rangers break up large tracts of timber with barren firebreaks. Every carpenter works by the phrase “The right tool for the right job.” Economists should be no less diligent than carpenters in selecting the right tools.
As applied to capital and currency markets, the correct approach is to break up big banks and limit their activities to deposit taking, consumer and commercial loans, trade finance, payments, letters of credit and a few other useful services. Proprietary trading, underwriting and dealing should be banned from banking and confined to brokers and hedge funds. The idea that large banks are needed to do large deals is nonsense. Syndicates were invented for exactly this purpose and are excellent at spreading risk.
Derivatives should be banned except for standardized exchange-traded futures with daily margin and well-capitalized clearinghouses. Derivatives do not spread risk; they multiply it and concentrate it in a few too-big-to-fail hands. Derivatives do not serve customers; they serve banks and dealers through high fees and poorly understood terms. The models used to manage derivatives risk do not work and never will work because of the focus on net risk rather than gross risk.
A flexible gold standard should be adopted to reduce uncertainty about inflation, interest rates and exchange rates. Once businesses and investors have greater certainty and price stability, they can then take greater risk on new investments. There is enough uncertainty in entrepreneurship without adding inflation, deflation, interest rates and exchange rates to the list of barriers standing in the way of innovation. The U.S. economy as guided by the Fed has seen continual asset bubbles, crashes, panics, booms and busts in the forty years since the United States left gold. It is time to diminish the role of finance and empower the role of commerce. Gold produces the greatest price stability in prices and asset values and therefore provides the best visibility for investors.
The Taylor rule, named for its proponent economist, John B. Taylor, should guide monetary policy. The rule utilizes positive feedback loops by including actual inflation in its equation while offering simplicity and transparency. It is not perfect, but, to paraphrase Winston Churchill, it is better than all the others. The combination of the Taylor rule and a flexible gold standard should make central banking a boring occupation, which is exactly the point. The more drama that can be removed from central banking, the more certainty that will be provided to entrepreneurs, who are the real source of jobs and wealth creation.
Other suggestions to reverse the impact of complexity include elimination of the corporate income tax, simplification of the personal income tax and reductions in government spending. Opposition to ever larger government is not ideological; it is merely prudent. When the risk of collapse is in the scale itself, the first-order benefits of government programs are dominated by the invisible second-order costs. Smaller is safer.
What the recommendations above have in common is that they all shrink or simplify the financial system or, in the case of gold, build bulkheads against collapse. Critics will say that many of these proposals are backward looking to a time of less government and less complexity in banking, fiscal policy and monetary policy. They will be right and that is exactly the point. When you have moved to the negative marginal-return section of the complexity input-output curve, going backward is a good thing to do because society will be more productive and more robust to catastrophe.
If remedial policies are not adopted and events do spiral out of control, the Pentagon will inevitably be called upon to restore order in ways that the Treasury and Fed cannot. The threats envisioned in the Pentagon’s 2009 financial war game are becoming more real by the day. Secretary of Defense Robert Gates, upon being briefed on the financial war game, said it was “an eye-opening experience” that “reflected some shortcomings in the ability and willingness of different parts of the government to share information.” Gates did not mention the U.S. Treasury by name; however, my experience is that the Treasury and the Fed need to work more closely with the national security community to help the country prepare for what may lie ahead.
As I noted at the outset, a book on currency wars is inevitably a book about the dollar and its fate. The dollar, for all its faults and weaknesses, is the pivot of the entire global system of currencies, stocks, bonds, derivatives and investments of all kinds. While all currencies by definition represent some store of value, the dollar is different. It is a store of economic value in a nation whose moral values are historically exceptional and therefore a light to the world. The debasement of the dollar cannot proceed without the debasement of those values and that exceptionalism. This book has tried to offer fair warning of the dangers ahead and be a compass to help steer away.
Social and financial collapses have happened many times but are easily ignored or forgotten. Yet history does not forget, nor do complex systems refrain from doing what they are wont to do. Complex systems begin on a benign organizing principle and end by absorbing all available energy while destroying the system itself. Capital and currency markets are complex systems and will collapse in the end unless they are broken up, contained, compartmentalized and descaled. Currency wars are ultimately about the dollar, yet the dollar today is just a jumped-up version of a former self due to derivatives, leverage, printing and the derogation of gold. It is not past time to save it. Still, the time grows short.
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