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Hedge fund and foreign exchange mogul Stanley Druckenmiller believes that the Fed's current policies and US deficit spending are putting the dollar on a path to collapse. This morning, he told CNBC that there is a "good chance" that the dollar will lose its status as the world's reserve currency within 15 years. Druckenmiller's comments focused on the Fed's commitment to low interest rates and US bond buybacks, which will ultimately support the US's deficit spending to fight the pandemic. Still, Druckenmiller’s comments are positive for a group that is already effectively shorting the dollar: cryptocurrency advocates. With the euro in trouble and the yuan still under suspicion, Druckenmiller doesn’t see another fiat currency taking on the dollar’s universal mediation role anytime soon. Instead, he sees a “crypto-derived ledger system” as the “most likely replacement” for the dollar. It’s a remarkable set of statements from Druckenmiller, who some consider the greatest foreign exchange trader in history. He was behind Soros’ legendary 1992 bet against the British pound, among other big trades. Now he’s echoing one of the most fundamental points of Bitcoin advocates, who for a decade have contrasted Bitcoin’s fixed issuance with countries’ propensity to let their printing presses run wild. Inflation hasn’t been a major worry for the U.S. economy for decades. In fact, before the pandemic, the Federal Reserve had considered inflation too low for nearly a decade. But pandemic spending has pushed U.S. deficits and debt to record highs, raising widespread concerns about inflation risks. Inflation can be the biggest headache for dollar-denominated investors because it erodes their assets and earnings. It can also be an annoyance for workers and consumers, even though wages tend to rise with prices. If the dollar becomes less attractive as a tool for foreign governments and global traders, the loss of its global reserve currency status could be a complete disaster for almost all Americans. According to the International Monetary Fund, approximately 40% to 72% of U.S. paper money is held abroad, and the dollar accounts for more than 60% of the world's national foreign exchange reserves. If confidence is damaged, attempts to sell these positions could create a vicious cycle in the value of the dollar, which would have a series of negative effects within the United States. While the long-term trend in U.S. debt is clear, it is far from clear that the time has come to rein in spending. Druckenmiller argues that the U.S. recovery is now so strong that further pandemic relief spending is unnecessary and even risky, but relief spending seems essential to getting there in the first place. Indeed, some argue that the U.S. response has helped it “win the pandemic” by making up for the widespread collapse in demand. Some also argue that the pandemic relief has prevented the economy from suffering the same degree of damage as the Great Depression, which may have damaged the dollar’s international standing as much as mild inflation, if not more. Rather than questioning the importance of relief spending, Druckenmiller argues, more modestly, that it’s time to scale back. This is a broadly Keynesian view: increase the deficit when the private sector is shrinking, then reduce it when the overall economy is recovering. It’s also arguably a case of hindsight, since the current rescue package, some of which will last for another six months, was in the works before the successful rollout of a vaccine in the U.S. was certain. Even its current merits are debatable, for example, with the U.S.’s actual unemployment rate still above 10%, suggesting that the overall economy has plenty of slack. This is just one of the big differences in what inflation means at different income levels. As mentioned earlier, generally speaking, investors and the wealthy have the most to lose from inflation because it eats up dollar-denominated returns while also diluting the value of dollar holdings. Meanwhile, workers, who are unlikely to have much savings or investments, have benefited disproportionately from pandemic relief spending and will suffer the most when it ends. Druckenmiller's reserve currency endgame scenario shows that irresponsible government spending will ultimately hurt everyone, but in the short term, pandemic relief has made many ordinary people much better off than they would have been otherwise. This point is almost never acknowledged in the broader discussion of inflation, but it’s clear if you contrast current inflation concerns with the response to former President Donald Trump’s 2017 tax cuts. The Congressional Budget Office estimated that even with the additional growth from the cuts, the U.S. deficit would increase by $1.9 trillion over the next decade. That’s as big a budget gap as President Biden’s American Rescue Plan, but after the tax cuts, there’s barely any sign of inflation. Even more remarkable is that the spending cuts are coming during a strong economy, which conventional wisdom holds is economically unnecessary and more likely to stoke inflation than spending during a slowdown. Even more confusing is that many of the same people who worry about massive inflation are also opposing Biden’s attempts to reverse some of Trump’s spending cuts. All of this suggests that any transnational reserve currency, cryptocurrency or otherwise, could pose broader challenges. While there are legitimate concerns about inflation, deficit spending is an important tool for nation states to meet local political and social needs, particularly to protect the most vulnerable members of society during crises. In the worst-case scenario, a global currency replacing a national currency entirely would limit a government’s fiscal discretion to take such action. This can be seen in the problems that countries like Spain and Greece experienced after abandoning their own currencies in favor of the euro. But for those countries that retain viable national currencies, a supranational reserve currency may be more of a moderating force than a restrictive one, especially if it can be accepted by the general public. Right now, if your own currency is mismanaged, the main options are to find other countries that are doing a better job, or to buy gold. But a neutral, inflation-resistant reserve layer may be a better refuge. If it is easy to buy and hold (e.g., via a public blockchain), distrust of the government's fiscal policy will quickly be punished through a drop in demand for the currency. At the same time, the government still has the flexibility to issue debt denominated in its own currency when it is truly needed and supported by public sentiment. But it’s hard to see a path that doesn’t wreak havoc on the dollar and the U.S. overall. After all, $1.9 trillion in pandemic spending is being added to a government debt that now exceeds $28 trillion. If market confidence in the dollar weakens, leading to less global appetite for holding Treasuries, higher interest rates could require a third of the U.S. budget to go toward interest payments, up from about 10% now, Druckenmiller said. That’s bad for everyone. |
