When Will the U.S. Dollar Collapse?

Will the Dollar Collapse in 2017?

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A dollar collapse would destroy the euro, pound and yen as well. Photo: Fanatic Studios/Getty Images

A dollar collapse is when the value of the U.S. dollar plummets. Anyone who holds dollar-denominated assets will sell them at any cost. The biggest holders are foreign governments who own U.S. Treasuries. They also include traders in exchange rate futures who trade the dollar versus other currencies. Last but not least are individual investors.

When the crash occurs, they will demand assets denominated in anything other than dollars.

The collapse of the dollar means that everyone is trying to sell their dollar-denominated assets, and no one wants to buy them. They will drive the value of the dollar down to near zero. It makes hyperinflation look like a day in the park.

Under What Scenario Will It Happen?

Three conditions must be in place before the dollar could collapse. First, there must be an underlying weakness. That situation exists. The U.S. currency is fundamentally weak despite its 25 percent increase since 2014. The dollar declined 54.7 percent against the euro between 2002 and 2012. Why? The U.S. debt nearly tripled during that time period, from $5.9 trillion to $15 trillion. The debt is even worse now, at $19 trillion. The debt-to-GDP ratio is now more than 100 percent. That increases the chance the United States will let the dollar's value slide. That would allow it to repay its debt with cheaper money.

Second, there must be a viable currency alternative for everyone to buy.

The dollar's strength is based on its use as the world's reserve currency. That happened in 1973 when President Nixon abandoned the gold standard.  As a global currency, the dollar is used for 43 percent of all cross-border transactions.That means central banks must hold the dollar in their reserves to pay for these transactions.

As a result, 61 percent of these foreign currency reserves are in dollars. Here's the 3 Ways to Measure the Value the U.S. Dollar.

If the dollar lost its status, what is the next most popular currency? The euro. But it comprises less than 30 percent of central bank reserves. The eurozone debt crisis weakened the euro as a viable alternative to the dollar as a global currency.

China and others argue that a new currency should be created and used as the global currency. China's central banker goes one step further. He claims that the yuan should replace the dollar to maintain China's economic growth. But replacing the dollar would be a massive undertaking. It would require great global resolve. It could not happen quickly. China is right to be alarmed at the dollar's drop in value. That's because it is the largest foreign holder of U.S. Treasuries, and it just saw its investment deteriorate. For more, see Dollar to Yuan Conversion and History.

Could Bitcoin replace the dollar as the new world currency?

It has many benefits. It's not controlled by any one country's central bank. It is created, managed, and spent online. But it can also be used at brick-and-mortar stores that accept it. Its supply is finite. That appeals to those who would rather have a currency that's backed by something concrete, such as gold. There are big obstacles, however. First, its value is highly volatile. That's because there is no central bank to manage it. Second, it has become the coin of choice for illegal activities that lurk in the deep web. That makes it vulnerable to tampering by unknown forces. 

What Event Could Trigger a Collapse?

A dollar collapse would not occur unless the third condition were also met. That's a huge, triggering event that would destroy confidence in the dollar. 

Altogether, foreign countries own more than $5 trillion in U.S. debt. If China, Japan or other major holders started dumping these holdings of Treasury notes on the secondary market, this could cause a panic leading to collapse. China owns more than $1 trillion in U.S. Treasuries. That's because China pegs its currency, the yuan, to the dollar. This keeps the prices of its exports to the United States relatively cheap. Japan owns more than $1 trillion in Treasuries. It also wants to keep its currency, the yen, low to stimulate exports to the United States Japan is trying to move out of a 15-year deflationary cycle. The 2011 earthquake and nuclear disaster didn't help.

Would China and Japan ever dump their dollars? Only if they saw their holdings declining in value too fast AND they had another export market. The economies of Japan and China are dependent on U.S. consumers. They know that if they sell their dollars, their products will cost more in the United States. Their economies will suffer. Right now, it's still in their best interest to hold onto their dollar reserves.

China and Japan are selling more to other Asian countries, who are gradually becoming wealthier. But the United States is still the best market in the world. See Demand in the U.S. Economy.

When Will the Dollar Collapse?

A dollar collapse will not occur in 2017. In fact, it's highly unlikely that it will collapse at all. That's because any of the countries who have the power to make that happen (China, Japan, and other foreign dollar holders) don't want it to occur. It's not in their best interest. Why bankrupt your best customer? Instead, the dollar will eventually resume it gradual decline once these countries slowly find other markets. For more, see Dollar Decline or Dollar Collapse? 

What Would Happen After a Collapse?

A sudden dollar collapse would create global economic turmoil. Investors would rush to other currencies, such as the euro, or other assets, such as gold and commodities. Demand for Treasuries would plummet, and interest rates would rise. U.S. import prices would skyrocket, causing inflation.

U.S. exports would be dirt cheap, boosting the economy briefly. In the long run, inflation, high-interest rates, and volatility would strangle possible business growth. Unemployment would worsen, sending the United States back into recession or even a depression.

How to Protect Yourself

Protect yourself from a dollar collapse by first defending yourself from a gradual dollar decline. Keep your assets well-diversified by holding foreign mutual funds, gold, and other commodities. A dollar collapse would create global economic turmoil. To respond to this kind of uncertainty, you must be mobile. Keep your assets liquid, so you can shift them as needed. Make sure your job skills are transferable. Update your passport, in case things get so bad for so long that you need to move quickly to another country. For more, see Dollar Collapse: How to Protect Yourself and Survive.

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