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The U.S. dollar has been the world's reserve currency since the end of WWII. Which made sense at the end of WWII because we possessed most of the world's industrial capacity and most of its gold at the time. So the dollar was pegged to gold and all the other currencies were pegged to the dollar and the dollar would be fully convertible into gold.
However, it soon became apparent that maybe having one country in charge of the world's trading currency wasn't such a great idea.
By the time the 1960's rolled around, it became apparent the U.S. was printing more dollars than they had gold. An economist named Robert Triffin pointed out that, any one country being the world's reserve currency would have to run a huge trade deficit to provide the money needed to grease the engines of world trade. This would cause them, he posited, to eventually go bankrupt.
And the U.S. did start to go bankrupt. Once everyone figured out there were more dollars than there was gold, they started trading in their excess dollars for gold. The situation got so bad that, in 1971, Nixon had to “temporarily” suspend the dollars convertability to gold. In effect, we defaulted.
Interestingly, we defaulted right around the time the West Texas oilfields reached their peak and the U.S. turned from being an oil exporter to a major importer.
Fortunately, the Saudi's were just getting going with their oil and could be bought off. In exchange for weapons and roads and infrastructure projects, the Saudis agreed to only accept dollars for their oil. This gave other countries a great reason to hold dollars—they needed them to buy oil. So we could continue to print dollars in exchange for stuff from other countries. In the 1960's Charles DeGaulle had called this ability endowed by being the world's reserve currency an “exhorbitant priveledge”.
It is a priveledge we still enjoy to this day. And just what does this “exhobitant priveledge” look like? It looks like 500,000 empty shipping containers.
That is the number of containers coming to U.S. ports full of stuff and leaving U.S. ports empty. The fact that other countries are willing to accept dollars for their stuff (instead of gold or different stuff) means that we do not have to produce goods of equal value to our exports (the way trade should work). We can just print dollars. Indeed, we have to print those dollars so other countries can use them for trade.
However, it appears that Triffin was right and that the U.S. is going bankrupt. The world is figuring out that they have too many dollars and they are looking for alternatives. China, for example, has just floated a bond priced in SDRs. In 2011, after decades of leasing and selling gold into the market, Central Banks around the world became net buyers of gold. China and Russia are rumored to be exceptionally large buyers of gold. They are also negotiating bi-lateral trade deals in local currencies around the world.
Right now these are small steps and rumors. But if they all of the sudden become big and real and the U.S. has to produce 500,000 shipping containers worth of stuff every year instead of just printing up dollars—what is going to happen to inflation then? If we have to fill those containers with corn and beef and cars—what will that do to the price of corn and beef and cars? What will it do to the price of bearings, if we have to pay for those bearings with gold or stuff?
Without this “exhorbitant priveledge” that we have enjoyed for the last 70 years, the U.S. standard of living will decline quickly and for a long time to come.
But for the time being, the Saudis are still only accepting dollars and the “exhorbitant priveledge” is ours to enjoy. And as long as it is, the price of bearings should remain pretty low.