my studies of past historical extreme cases in which these conditions existed and from our analysis of current and
upcoming supplies and demands for US money and debt, one can see that the US government, the Federal
Reserve, and the buyers of the debt are testing the limits of how much money and credit can be squeezed out of a
reserve currency without breaking it. From speaking to the most knowledgeable people in the world in this
domain, including those who are now running the world’s monetary and economic policies and those who did in
the past, there isn’t a single person I spoke with who when shown the evidence—i.e., both the historical cases in
relation to the current case and the current picture of the supplies and demands for dollar-denominated money and
debt—disagrees that we are in unprecedentedly risky territory and testing the limits of what’s possible. That
doesn’t mean that anyone is confident that the dollar will decline significantly in value or as a reserve currency in
the near future. The picture for the dollar and dollar debt is like (and related to) the picture for interest rates. If a
few years ago you had asked whether these extremities would be reached—i.e., whether we would have negative
nominal and real long-term interest rates with debts and borrowings so large in a capital market that governments
aren’t imposing capital controls on to force such circumstances—all these knowledgeable people would have said
“implausible.”That is because that never happened before and because it is tough to figure out why holders and
buyers of that debt would accept that deal rather than move their wealth into other things. One would have looked
at past extremities when the largest budget deficits and debt monetizations existed in such large amounts and
interest rates stayed low (which were war years when government capital controls were required and interest rates
were targeted) and looked at the most deflationary and depressing economic times, and one would never have seen
these things happen, so “implausible” would have been a smart assessment. Yet that is what has happened.
Now, by watching who bought what for what reasons we can understand why. However, the lesson is the same as
one regularly gets in the markets, which is that the implausible happens more often than one would expect. So
while most everyone, most importantly the world’s greatest experts, agrees that we are testing the limits, no one,
including me, should say with certainty that the dollar will be significantly diminished as a reserve currency
anytime soon. However, we can recognize what it will look like when it comes and know that, if it comes, it
probably won’t be able to be stopped. There will be a selling of dollar-denominated debt by holders of that debt as
they put their assets elsewhere and there will be lot of borrowing of dollar debt by smart debtors who will take
advantage of that cheap funding to make higher returns and these moves will require the Fed to choose between a)
allowing interest rates to rise unacceptably (because that rise would severely damage markets and the economy)
and b) printing money to buy a lot of debt, which will further reduce the real value of the dollar and dollar debt. As
described in Chapters 2 and 3, it will look like a classic currency defense. As explained in that chapter, when faced
with that choice central banks almost always print money, buy the debt, and devalue the currency, which becomes
self-reinforcing because the interest rates being received to hold the currency are not high enough to compensate
for the depreciating value of the currency. That continues until the currency and real interest rates reach levels that
establish new balance of payments levels, which is a fancy way of saying until there is enough forced selling of
goods, services, and financial assets, and enough curtailed buying of them by Americans so they can be paid for
with less debt.
The most often asked question regarding the dollar is, “How could the United States lose its reserve
currency status when there are no good alternative currencies to replace it?” So let’s look at that question
more closely. The reserve currency assets and their current percentages of total foreign exchange reserves held are
as follows: