Why the USD collapse will be obvious
Captain Hindsight
Following last week’s newsletter on bank collapses, world reserve currencies, hyperinflation, and investing I had quite a few questions. I thought it would be worth examining how history unfolds in relation to world powers and currencies.
History is one of those things that is so obvious in hindsight. Whatever happens, has a series of underlying reasons that bring it about. With some investigation, the causes pop out. Yet before events unfold, it is much less obvious.
No one expected World War I to happen. Then it happened. And no one had a clue what it would be like.
As the First World War made painfully clear, when politicians and generals lead nations into war, they almost invariably assume swift victory, and have a remarkably enduring tendency not to foresee problems that, in hindsight, seem obvious.
Adam Hochschild
After 1918 many things were put in place to ensure another war could never happen. These actions were the perfect breeding ground to set up World War 2.
Obviously to us, World War 2 was queued up to define the entire 1940s. Were you to ask someone in the year 1940 to predict the biggest events of the decade, it wouldn’t be war or nuclear bombs…
Currencies
On the subject of the USD as a reserve currency, let’s start with the basics.
The global reserve currency is the currency that is held in significant quantities by governments and institutions as part of their foreign exchange reserves. Currently, the US dollar is the dominant global reserve currency, but that wasn't always the case.
Throughout history, there have been many different global reserve currencies. The Dutch guilder was the dominant currency in the 17th century, and the British pound took over in the 19th century. Now, the US dollar is on top. But what causes these power shifts?
One major factor is economic strength. When a country's economy is strong, its currency tends to be in high demand. This is why the US dollar became the dominant global reserve currency in the mid-20th century. At the time, the US was the world's largest economy, and the US dollar was seen as a safe haven for investors.
But economic strength isn't the only factor. Political stability and military power also play a role. The British pound, for example, remained a dominant global reserve currency even as the UK's economic power waned because of the country's strong political and military influence.
Our poor grasp of history
Each country teaches its citizens a very narrow view of world history. It highlights the good deeds it has done and covers up the bad whilst emphasising its own importance.
History lessons in the UK teach us about the British empires crucial role in shaping the world and turning the tide in the World Wars.
Both Russia and America have a similar self-centred warp. They, of course, claim responsibility for winning the wars. In truth, we are all right. No one can say who won the wars because we were all involved and we can’t replay history without them.
Imagine a football (soccer) match where your team wins 6-5 over another team. Three players score twice for your team.
Each scoring player is responsible for winning the match, without their two goals you would have lost 4 -5.
Yet if that scoring player had never played, maybe someone else would of scored. This also forgets the essential contribution of every other player in the team that resulted in the victory.
The point is we are set up to be self-important and forget how others put is in our positions of success.
It’s mad how powerful the Netherlands was
I genuinely had no idea about the Dutch pioneering half of the principles that the British empire was built on. I was quite surprised when travelling in the Caribbean I discovered the Dutch Antilles and then in Malaysia, I found museums talking about Dutch ownership of half of South East-Asia…
The concept that a country the size of Belgium or Switzerland was at one point responsible for 25% of the world’s GDP and 30% of all inventions over 100 years seemed bonkers.
It’s mad how powerful Britain was
I am sure it is much the same for a citizen of the United States to look at tiny Britain as a world power much bigger than the US is now. At its height, a quarter of all humans alive were in the British Empire. That’s right, Britain, that small country the size of one single state in the US…
Population and the ingredients for power
As the global reserve currency shifted from the Dutch guilder to the British pound to the US dollar, there were significant jumps in the population size of each world power.
2 million people - Netherlands population - when the Dutch guilder was the dominant global reserve currency
18 million people - British population - when it took over in the 1850s
130 million people - US population - when the US rose to dominance in the 1940s
It's important to note that population size isn't the only factor that determines a country's economic and political power (China, India and Russia were always huge). Political stability, education, trade and military power are also key factors, and they can shift over time.
The Dutch Republic
was known for its political stability during the 17th century, which contributed to the success of the Dutch guilder as a global reserve currency. The Netherlands had a relatively decentralized government and a system of checks and balances that prevented any one person or group from accumulating too much power. This stability allowed the Dutch to focus on trade and commerce, which in turn fueled their economic success.
The British Empire,
on the other hand, was known for its military power and its ability to project that power around the world. It had lagged behind the Netherlands technologically but as it grew copied a lot of the Netherlands’ boat technology and hired its best shipbuilders.
Once Britain rose to power through copying it lead innovation to stay at the front of technology and power. This military might allowed the British to expand their empire and control trade routes, which helped make the British pound the dominant global reserve currency during the 19th century.
The US
became the dominant global power thanks in part to its military might and political stability. The US had emerged as a major world power after World War II, and it used its military and economic strength to shape the global order in its favour. The US also had a stable political system and a strong legal framework, which helped attract investment and maintain its position as a global leader.
Of course, political stability and military power can be subject to change. The Dutch Republic declined in the 18th century due to political and economic factors, and the British Empire began to decline in the early 20th century as its military power waned and other countries began to catch up economically.
Besides the ingredients for power, it’s useful to learn how power is prevented.
Opium of the masses
An interesting lesson from history we aren’t taught in Britain is the opium wars in China. (I also had no clue as to why Britain owned Hong Kong until I learnt about this)
When Britain was growing as a world power it depended on China for many imports but faced restrictions from China, which only accepted payment in silver and didn’t care for British goods. Opium was illegal in China so Britain started selling opium for goods as a cheaper alternative to silver.
China tried to crack down and destroyed a large amount of British-owned opium and ships. Britain saw this as a declaration of war and sparked the first opium war of 1839-1842 leading to British victory.
The treaty of Nanking gave Britain control of Hong Kong where citizens were subject to British law and allowed Britain to open more ports in China. The opium trade grew vastly and a second opium war with Britain and France led to even more ports opening up.
With Western Powers, particularly Britain, controlling the opium trade they aggressively marketed it to the Chinese (whereas in Britain it was a regulated substance with strict laws on its sale).
China became dependent on the drug which devastated the economy and society and ultimately led to the fall of the Qing dynasty which ruled China from 1644 to 1912.
In China, the opium wars are still remembered as a symbol of Western Imperialism and are called ‘the hundred years of shame’ for the country.
To all those who have suffered as a consequence of our troubled past, I extend my sincere thoughts and deep sympathy. With the benefit of historical hindsight, we can all see things which we would wish had been done differently or not at all.
Queen Elizabeth II
There is an interesting parallel with Tik Tok…
which appears to be highly addictive and has proven negative impacts on concentration, memory and learning.
In the West, we are pulling our hair out trying to work out how to stop our kids from using it so much whereas in China it has been regulated for a long time with a maximum of 40 minutes in daytime hours only (they have a similar law on video games).
Of course, I’m not saying China is deliberately exporting damaging addictive apps for its own empowerment. The West would happily be addicted to YouTube, Facebook and Instagram without Tik Tok.
However, China’s stricter control of technology in its nation is something that could be beneficial.
As our devices only get better at stealing our attention, amplified by the blistering pace of change we are about to go through with AI. The West’s liberal nature of individual freedoms is a flaw that will be hard for us to police when it is so fundamental to our rights otherwise.
Work is hard. Distractions are plentiful. And time is short.
Adam Hochschild
The next World currency
China has long been thought of as a poor and underdeveloped nation. In the past 30 years, its nation has risen out of poverty and working in the fields to a dominant middle class.
The country is highly educated and the largest trading partner for most countries in the world. You only need to spend a small amount of time travelling across Asia to see that the Chinese are considered rich tourists there.
We all know how much stuff is made in China. This includes the manufacturing of most of our technology.
Ultimately, this means more countries rely on China for their economic well-being than the United States. With countries like Russia, Brazil and Saudi moving to the Chinese RMB for trade, the signs of the Dollar decline are here.
Population comparison
Examining the population jump of each country as the World currency changed hands it seems obvious. As soon as Britain matched the Netherlands in terms of education and technology whilst maintaining a good economy, it outclassed the Netherlands. Ten times more people with the same tools, education and ecosystem will understandably win.
As soon as the United States matched Britain in education, economy and stability giving equal opportunity for output per worker it blasted Britain out of the water.
China has 1.4 billion people (US now has 332 million).
Currently, Chinese culture has a very strong work ethic assisted by good technology and a brilliant education system. Public university is practically free, as is healthcare.
In the US, students must take on a lot of debt to study and the healthcare system is an expensive mess.
It's all to do with the training: you can do a lot if you're properly trained.
Queen Elizabeth II
A recent study found the average Chinese child wants to be an astronaut, whereas in America they want to be an influencer.
If you were to withhold assumptions and use the facts to bet on the future success of a 20-year-old Chinese individual versus an American, it would be the Chinese every time. And there are 4 times more of them.
But China can only copy things
The most common argument I hear against China is that it can’t invent anything and only copies things.
Examining history this strategy seems obvious. If you are a nation behind on technology the only sensible thing to do is copy the more advanced countries. Exactly how Britain copied the Dutch boats and its banks until it was the leader.
Only once you are the leader in technology does it makes any sense to innovate.
Over the past thousands of years, the Chinese have invented many things with breakthroughs in science, engineering, healthcare and philosophy.
The concept that China is a backwards nation of copycats who can’t think for themselves is just dumb and racist.
The ‘China can only copy’ assumption is a dangerous lie we can choose to tell ourselves if we wish.
So USD is ruined?
I have no idea.
Those who have knowledge, don't predict.
Those who predict, don't have knowledge.
Lao Tzu
I’ve merely explained a few of the first principles of why if the USD collapses and is replaced by the Chinese RMB, it will be very obvious in hindsight.
Besides the reasons listed above, there will probably be many others I haven’t dived into. Last week I spoke about the debt crisis, bank collapses and hyperinflation and how they fit into the macroeconomic cycle.
Again I can highly Ray Dalio’s work in his book “The Changing World Order: Why nations succeed and fail” and his other resources here - EconomicPrinciples.org
Other factors such as the war in Ukraine, tensions with Taiwan and the growing political divide and infighting in America aren’t helping and there will be a multitude of things no one would even expect.
There is also the potential that the BRICS set up a new currency (rumours based on a statement). As they overtake the G7 in terms of economic output and transition away from the dollar they could make an entirely new system instead of relying on any single currency of one nation.
In all, last week was an interesting week of news (27th March 2023 - 2nd April):
What about Bitcoin?
There is a whole other possibility of Bitcoin rising as the world currency as it is not inflationary and neither is it controlled by a state. I expect it isn’t ready for world adoption just yet.
With 100 million Bitcoin users it seems like too much of a jump and the user experience of blockchain is still terrible.
I can certainly see a jump to something like Bitcoin in the future as we realise that a world reserve currency controlled by a single state (or group) is kind of dumb. And it follows the trend of population growth that after China the next logical population is the whole world.
The planet is progressively shrinking. Future events such as humans reaching Mars and newer generations living digital lives could reduce identification with the country they are from.
I think these factors could push us towards a truly global currency.
So there’s a theory for you.
But what’s happening?
If it annoys you that I haven’t told you what will happen, it’s helpful to remember the Dunning-Kruger effect that stupid people are confident, while the intelligent are doubtful.
If we listen to people with high confidence it’s likely they haven’t done a good job of thinking through possibilities and are just shouting loudly what they want to be true.
So as ever, we can only truly rely on Captain Hindsight and in the meantime try to not be dumb from lessons he’s already taught us.
Some other lessons from the past you might want to pay attention to :)
