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The case for a strong Dollar

Updated: Mar 5, 2021

The economic system after the war was centered on the $ but was not designed for the $ to be strong.

Initially US, the emerging Empire (with a trade surplus) acted as a benevolent Country reinvesting that surplus in Europe and Japan to finance their re-industrialization (Marshall Plan). During the years that followed, the trade surplus became a growing deficit and US Governments started to abuse their faculty of printing money. In 1973 the link to Gold was removed and a floating currency exchange rate mechanism began. Since then US had had a twin deficit (budget and trade) almost every year. From a lender of last resource they became a spender a first resort.This privilege was possible because the $ is, de-facto, the reserve currency of the World.


The original theory was to smooth the business cycle giving central banks the responsibility for managing the money supply. It was their duty to control inflation regardless of the spending of politicians. Central Banks became the master of Universe and during the down phase of each business cycle they keep lowering rates, hoping to stimulate demand. After each recession the recovery was less and less effective (weakening productivity growth). In 2008 to avoid deflation and another great Depression they pushed once again short term Interest rates to 0 to save States( Governments could now pay no interest on their Debt) and Banks (QE).The injection of cash by the world’s four major central banks contributed to divert more capital towards the financial market rather than to productivity-enhancing investments It was there that Financial capitalism took off because the banking system reinvested that money on Wall Street instead of financing high street. The consequence for normal citizen around the world were devastating. They lost big because:


1) A wealth tax was imposed on normal citizen. Those few who had bought financial assets to protect against 0 interest rates saw their wealth increased; the majority lost because with interest rates at 0 and inflation low real Interest rates were negatives. In practice people were losing purchasing power year after year.


2) Income tax: The globalization of production was the consequence of freedom of movement of capital and labor. The consequence was the industrialization of the emerging Countries( with a low cost of Labor) and the de-industrialization of the West where wages stagnated for years


3) Automation tax. The new born digital economy and the coming 4th industrial revolution promise to help big corporations in the years to come because the automation of process of production will reduce their costs of production. This also means that many workers with low skills will be replaced by machines and experience unemployment, stagnant wages or unstable save and invest patterns.


Under these lenses we better understand the birth of populism and nationalism in the West which was simply a response to these global trends that were not benefiting the many. Populist simply refused to accept the narrative of liberal world order. With the rise of automation we will probably see the rise of populism in emerging countries as well because many production processes will be brought back to advanced Countries. In fact, Robots will be able to reduce cost of production the same as the outsourcing the production to emerging countries did in the previous decade.


The European union is a special case. During the crisis, member states faced the same problems described above plus external trade imbalances between surplus and deficit Countries members .Since the automatic mechanism of re-equilibrium of their balance of Payment (devaluation /revaluation of national currencies) was removed with the birth of the single currency (Euro) ,Creditor Countries of the north finished to impose austerity to the debtors countries of the south.


Today's money is simply Debt with interest. In a modern capitalistic society the finance of production comes before the production itself. In an environment where government spending is constrained (fiscal policies) and Monetary policies have become ineffective Sovereign debt crisis is alive and i fear it won't end well(in Europe in particular)


What is going to happen ?

After 50 years accumulated debt in the economy is so big that this is stopping the correct functioning of the capitalistic system. Can we assist at the collapse of this economic system based on $ in the coming year? We need to look at the Dollar. "Smart money" will concentrate their wealth in $ assets. One consequence of the Dollar strength will be the rise of commodity prices around the world (commodities are sold in $) and of production costs overall. Central Banks won't be able to stop this trend this time (monetary policies have become ineffective). Fiscal policies will be used and Interest rates will rise. An economic Stagflation is coming?


A strong $ will re-balance the current US trade deficit but the US economic machine will stop working properly because, as I said at the very beginning, the current system was not designed for a "strong" dollar. The panic of a System failure based on $ will probably cause a rush to Gold, the ultimate perceived store of value. A new monetary system with a global currency for international payment will emerge afterward. Today an inverted yield curve signal recession that will only arrive 18 -24 month later.This is bad for banks (borrow short and lend long). A speculative time to the horizon (borrow long and leverage short) instead.


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