When Will the US Dollar Collapse?

How and When That Could Occur

collapsing dominos with international currency symbols on them
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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. That includes foreign governments who own U.S. Treasurys. It also affects foreign exchange futures traders. Last but not least are individual investors.

When the crash occurs, these parties 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. This will drive the value of the dollar down to near zero. It makes hyperinflation look like a day in the park.

© The Balance, 2018

Two Conditions That Could Lead to the Dollar Collapse

Two conditions must be in place before the dollar could collapse. First, there must be an underlying weakness. Between 2002 and 2018, the dollar declined 6% according to the U.S. Dollar Index. Why? The U.S. debt almost tripled during that period, from $6 trillion to $22 trillion. The debt-to-gross domestic product ratio exceeded 100%. That increased the chance the United States would let the dollar's value slide so it could 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. The dollar became the reserve currency in 1973 when President Richard Nixon abandoned the gold standard. As a global currency, the dollar is used for half of all cross-border transactions. That requires central banks to hold the dollar in their reserves to pay for these transactions. As a result, 61% of these foreign currency reserves are in dollars.

 

The next most popular currency after the dollar is the euro. But it comprises less than 30% of central bank reserves. The eurozone debt crisis weakened the euro as a viable global currency.

China and others argue that a new currency should be created and used as the global currency. China would like it to be its currency, the yuan. That would boost China's economic growth. China is right to be alarmed at the dollar's drop in value. It's the largest foreign holder of U.S. Treasurys, so it just saw its investment deteriorate. The dollar's weakness makes it more difficult for China to control the yuan's value, which is pegged to the dollar.

It's unlikely bitcoin could replace the dollar as the new world currency. Its value is highly volatile because there's no central bank to manage it. It's also become the coin of choice for illegal activities that lurk in the deep web. That makes it vulnerable to tampering by unknown forces. 

The Economic Event that Could Trigger a Collapse

A collapse couldn't occur without a triggering event that destroys confidence in the dollar. 

Altogether, foreign countries own more than $6 trillion in U.S. debt. The two largest are China and Japan. If they dump their holdings of Treasury notes, they could cause a panic leading to collapse. China owns $1.1 trillion in U.S. Treasurys. That's because China pegs the yuan to the dollar. This keeps the prices of its exports to the United States relatively cheap.

Japan also owns more than $1 trillion in Treasurys. It also wants to keep the yen low to stimulate exports to the United States. Japan is moving out of a 15-year deflationary cycle. The 2011 earthquake and nuclear disaster didn't help.

Would China or Japan ever really dump their dollars? Only if they saw their holdings declining in value too fast.

They would also need another export market to replace the United States. The economies of Japan and China are dependent on U.S. consumers. They know that if they sell their dollars, their action would further depress the value of the dollar. So their products, still priced in yuan and yen, would cost relatively more in the United States. Their economies would suffer. Right now, it's still in their best interest to hold onto their dollar reserves.

China and Japan are aware of their vulnerability. They are selling more to other Asian countries that are gradually becoming wealthier. But the United States is still the best market in the world.

When Will the Dollar Collapse?

It's unlikely that the U.S. dollar will collapse at all. Countries that have the power to make that happen, such as 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 resume its gradual decline as these countries find other markets. 

Effects of the Dollar 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 Treasurys would plummet, and interest rates would rise. U.S. import prices would skyrocket, causing inflation.

U.S. exports would be dirt cheap. This would give the economy a brief boost. But 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. These are just a few ways to protect yourself and survive a dollar collapse.