The U.S. Dollar Index (USDX) is a number that measures a “teeter-totter” relationship between the U.S. fiat dollar (on one end of the “teeter-totter”) and six foreign, fiat currencies (sitting on the other end of the “teeter-totter”). That relationship measures the relative inflation/deflation between the U.S. dollar and the other six currencies.
The six foreign currencies and their relative “weights” in the USDX are:
Euro (EUR), 57.6% weight
Japanese yen (JPY) 13.6% weight
English pound sterling (GBP), 11.9% weight
Canadian dollar (CAD), 9.1% weight
Swedish krona (SEK), 4.2% weight
Swiss franc (CHF) 3.6% weight
First, note that the most heavily-weighted foreign currency is the euro which makes up almost 58% of the total “weight” of the six foreign currencies in the USDX. Changes in the perceived purchasing power of the euro can have a significant effect on the USDX. Changes in the purchasing power of the Swiss franc (just 3.6% of the total weight of the six foreign currencies) will have only a negligible effect on the USDX.
Conversely, changes in the U.S. dollar’s inflation or deflation rate can have a huge effect on the purchasing power of the euro but only a negligible effect on the purchasing power of the Swiss franc.
Second, a rise in the USDX number indicates that the U.S. dollar is deflating and gaining in purchasing power as compared to the six other, foreign currencies.
Because there’s an inverse, “teeter-totter” relationship between the US dollar and the other six foreign currencies, when the USDX rises and indicates dollar deflation, the average purchasing power of the other six currencies must fall as an indication of inflation.
If the USDX is falling, that means the U.S. dollar is inflating (losing purchasing power) and the six foreign currencies are, on average, deflating (gaining purchasing power).
Third, while inflation is great for debtors (they can repay their debts with cheaper dollars), deflation is terrible for debtors since they must repay their debts with more expensive dollars. Deflation can bankrupt debtors. In a debt-based monetary system like ours, deflation is as unwelcome as garlic at a vampires’ convention.
Fourth, the US government is the world’s biggest debtor and therefore has a vested interest in inflating the dollar so it can repay its debts with cheaper dollars.
Fifth, the world’s brave, new Keynesian economists believe that their countries need a “healthy” 2% inflation to stimulate their national economies and help them rise up out of the current economic recession and/or depression. (In fact, no inflation is truly “healthy” but “healthy” is promoted as a justification for inflation.)
Sixth, given that the struggling, overly-indebted economies want to cause inflation for their national currencies, all of the six foreign currencies should want the USDX to go up (dollar deflation) in order to cause or contribute to inflation of the euro, yen and the four other foreign currencies. Therefore, for the euro and yen to inflate and “stimulate” their economies, the dollar must deflate and cause stagnation or even decline for the U.S. economy.
• Thus, the relationship between the two ends of the USDX “teeter-totter” is adversarial. If one end goes up, the other end must go down. The resulting adversity provides the foundation for modern “currency wars”.
Why? Because the central banks can’t directly cause one currency to lose value (inflate and stimulate its national economy) without indirectly causing other currencies to gain value (deflate and slow their economies). Likewise, central banks can’t directly cause some currencies to gain value (deflate) without indirectly causing others to lose value (inflate). This is the inevitable consequence of the USDX’s “teeter-totter” relationships.
Today, central banks can’t use inflation to make some economies get stronger without simultaneously making others get weaker. All of the economies can’t rise together due to inflation. For some to rise, others must fall. In this, we see the cause for currency war. More, we can even find the rationale for inflating—and thereby destroying—our own currency into order to stimulate our economy.
Contrary to what I’ve just written, for 18 months out of the past two years, the U.S. allowed the USDX to rise, causing international U.S. dollar deflation that tended to slow our economy. For me, that rise was contrary to the economic interests of the U.S. and therefore inexplicable—except as evidence that the Federal Reserve had voluntarily choosen to accept U.S. deflation and U.S. economic slowdown as a sacrifice made to help inflate the euro and yen and thereby stimulate the faltering EU and Japanese economies. That hypothetical sacrifice hasn’t worked very well for the EU and Japan and has worked adversely for the U.S. economy.
Result? In the past month or six weeks, the USDX has begun to fall signaling dollar inflation. I can’t prove it, but I suspect that the Federal Reserve has abandoned its efforts to voluntarily accept dollar deflation and thereby stimulate EU and Japanese economies.
Takeaway? Despite some evidence of monetary sacrifice, the USDX measures an inherently adversarial relationship between fiat dollars and six other fiat currencies. The central banks may “play nice” from time to time, but the inherent nature of fiat currencies and the USDX is adversarial and our fate is therefore, “endless currency war for endless inflation/economic-stimulation”.
• All of the currencies involved in the USDX are fiat. They have no intrinsic value and aren’t backed by anything tangible like ounces of physical gold or silver. The purchasing power of each fiat currency is instead defined in terms of the other six currencies. As a result, the Federal Reserve can’t inflate the dollar (to stimulate the U.S. economy) without causing some of the other six currencies to deflate and slow their economies. Likewise, other central banks can’t inflate the foreign fiat currencies (to stimulate their national economies) without also deflating the U.S. dollar—which should slow the U.S/ economy.
For our economy to rise, the other six economies must, on average, tend to fall.
You can see the problem.
All fiat currencies can’t all inflate at the same time. Thus, all national economies can’t be stimulated at the same time. For one or more economies to be stimulated, some of the others have to sink into stagnation or depression.
This problem can be negotiated and mitigated so long as the global economy is running fairly strong and only one or two of the USDX nations are in a state of recession.
However, when the global economy falters (as it is now) and all seven USDX nations are in recession, all of them want inflation and none can easily endure deflation. Result? During global recession the USDX relationships are necessarily adversarial.
• This adversity is a necessary and inescapable consequence of having a world full of fiat currencies, none of which are backed by gold.
Since the fiat dollar is not backed by gold, the dollar’s value must be defined in terms of something and they’ve decided to define with the USDX it in terms of six foreign fiat currencies that are also not backed by gold and are therefore defined only in terms of the other fiat currencies.
It’s like algebra where x = 2y and y = x/2. Those are interesting relationships, but they tell us nothing tangible unless someone provides a concrete definition for either x or y. Because both x and y are intangible (unlike ounces of gold, gallons of water, inches, feet or miles) we have no objective measure for x or y. Until at least one of those variables is objectively defined, they are imaginary in the sense that they have no fixed, concrete relationship to the real world.
As another metaphor, consider the USDX as a means for measuring the length of a constantly stretching and contracting rubber band (the fiat dollar) by comparing it to six other constantly stretching or contracting rubber bands (the six foreign fiat currencies). We may know that rubber band #1 is twice as long as rubber band #2, and that #2 is 5 times longer than #3, and #3 is one-tenth as long as #1—but until we find a fixed reference point (like a 12-inch ruler or an ounce of gold) for at least one of those “rubber bands,” we can’t know how long any of those rubber bands may actually be.
Similarly, the USDX provides mathematical relationships, but no fixed values. It’s like quantum mechanics for economics.
• We can infer from the adversarial, USDX relationship between the fiat dollar and six other fiat currencies that, once the world abandoned an asset-/gold-based monetary system and adopted a fiat, debt-based monetary system, the end result must be the demise of fiat currencies. There’s no other possible outcome.
Why? Because in our fiat-currency world, sooner or later, one or more nations will fall into economic recession or depression. When they do, their politicians will seek the easiest way to “stimulate” their national economy, calm their voters and win reelection. When it comes to stimulating a national economy, what could be easier than inflating the national currency by simply printing a few trillion more dollars, euros or yen?
If that recessed or depressed economy had a currency whose value was set in terms of fixed ounces of gold, and if they wanted to inflate their currency by raising the price of gold, they could do so without causing much harm to other countries. I.e., yesterday, the price of gold was $20/ounce; today, that price has been raised to $35/ounce. Generally speaking, that change is not much skin off the noses of other nations.
But in a fiat-currency world (unless there are national price controls), every fiat currency is defined in terms of other fiat currencies and therefore has no fixed, tangible value. Its value is only relative.
When one nation inflates its currency to stimulate its economy, it necessarily causes other currencies to suffer a relative deflation which slows their economies. That forces the politicians in these other economies to also inflate their currencies in order to offset the deflation and economic recession caused by the first country’s inflation.
Result? Currency wars.
When the other countries retaliate by also inflating their currencies, that’ll push the first country back into deflation and economic depression—which will force the first country to, again, inflate its currency—which will cause deflation and depression in the second tier of countries, which will force them, as an act of self-defense, to retaliate with yet another round of inflation, etc., etc..
The only remedy is to enter into hard, enforceable treaties where each nation agrees to accept some fixed monetary relationship where the euro is always equal to, say, 1.25 dollars and the dollar is always worth 3 Swiss francs, and the Swiss franc is always worth 4 Japanese yen. Under treaty law, no nation can change those ratios by unilaterally inflating the value of its own currency without violating the treaty.
Treaties all seem very official and reliable until one of the signatory nations slides into a recession and Its politicians argue that they aren’t to blame. No. The fault was that damnable treaty that declared the Swiss franc is always worth 4 Japanese yen, when any fool could see that the Swiss franc should really have been valued at 3 Japanese yen. See, the villains who negotiated the treaty robbed Switzerland. OMG!
Swiss politicians will argue that that “robbery” entitles Switzerland to fire up the printing presses to produce another trillion Swiss francs to inflate the Swiss currency and rescue the Swiss economy from depression.
• See, that’s the great thing about fiat currencies: it’s easy to to stimulate an economy by inflating the national, fiat currency by simply printing another trillion or two fiat francs, euros or dollars. In fact, it’s so easy to inflate a fiat currency that no living politician, faced with a national recession or depression, is likely to resist the temptation to print/inflate.
That’s why politicians love fiat currency. They can advocate any hare-brained scheme (“Entitlements for ALL!”) that’ll get them elected, and when the idiocy hits the fan and the economy starts to collapse, all they have to do is print up a few trillion more units of fiat currency and—Presto-Changeo!–the greedy fools who comprise the public will get back to work, buy more stuff, and the recession will be over.
Is this a great monetary system, or what?!
Conversely, that’s why politicians hate a gold-based monetary system. Unlike fiat currency, politicians can’t “spin” ounces of physical gold out of thin air. They can’t easily inflate a national monetary system that’s based on gold. That means politicians can’t avoid the adverse economic consequences of their last hare-brained scheme (“Obamacare for all, Comrades!”)—by inflating their currency. That means that the politicians who came up with the hare-brained scheme (“Negative Interest rates! Yay!”) that nearly collapsed the economy might be held personally liable for their stupidity, tossed out of office or even shot.
And that means, politicians in a gold-based monetary system have to behave responsibly. No hare-brained schemes.
Well, heck, that takes all the fun out of being a politician, doesn’t it? Who wants to be a politician if you have to be wise, prudent, and worst of all, responsible?
But, that’s what a gold-based monetary system can do: force politicians to be responsible. So, you can see why politicians hate gold money and love fiat currency.
• The problems with a global, fiat monetary system are four-fold:
First, so long as all the currencies of the world are fiat, they’re all adversarial in relation to the others. If any nation directly inflates their own currency, they’ll necessarily cause some indirect deflation (and economic recession) in other countries. The resulting adversity can predispose some nations to go to war.
Second, every so often and much to everyone’s surprise, the fool public gets smart and stops rising to the fiat currency “bait”. No amount of extra billions of fiat currency will tempt the public to work harder or purchase more stuff. That’s what’s currently happening in Japan and to lesser extents in the EU and US economies.
Inflation is no longer easy. Governments and central banks can’t simply print more billions of fiat dollars to paper over their hare-brained schemes.
Third, in a fiat-currency world, fiat dollars must die. If foreign countries inflate, the Federal Reserve should respond by inflating the fiat dollar. If we inflate, they must also inflate. The resulting “death-spiral” is currency war. That explains why the fiat dollar that had 100 cents purchasing power in A.D. 1971 is now worth less than a nickel. Soon, currency wars fought by means of inflation will reduce the dollar’s purchasing power to 4 cents, then, 3 cents, 2 cents, 1 cent and one day—just like the Wiemar Republic’s mark or the Zimbabwean dollar—it’ll be worth zero cents and therefore dead. Sic semper fiat pecunia!
You can bet that once the fiat dollar dies, all other fiat currencies will have already died or will soon after follow into oblivion. It’s the nature of fiat currencies to ultimately suffer a “mass extinction event”.
Fourth, there’s going to be a day of reckoning when politicians and economists who instigated, advocated, exploited, justified and/or defended fiat currencies (and all of the hare-brained political schemes it fostered) will be held up to public ridicule, possible trials or (remotely) even executions. Those tribulations will be seen just before, or shortly after, each nation’s fiat currency dies and the nation is plunged into poverty and chaos.
• If the fiat monetary system seems confusing, it’s not because you’re stupid or even ignorant. It’s because that system was irrational to begin with that it seems incomprehensible. We have a global, fiat monetary system that was designed by economists who got their master’s degree from the Mad Hatter’s School of Economics and their PhD from the Bernie Madoff Academy of Corporate Ethics.
Where’s it all heading?
As each nation tries to stimulate their own economy by inflating their own currency, they cause other nations to suffer deflation and economic depression. The depressed nations will counter with their own currency inflation.
And, of course, the first nations to inflate will react by causing another, even greater, round of inflation. As this tit-for-tat continues and amplifies, we’ll see higher and higher rates of inflation until we slip into global hyperinflation. In global hyperinflation, every nation’s fiat currency follows in the footsteps of the Wiemar Republic’s mark and Zimbabwean dollar by inflating into worthlessness and destruction.
I don’t know when our fiat dollars will hit the hyperinflationary fan, but I can’t believe it’ll be more than a few years from now. The only way we might avoid hyperinflation is if cooler heads prevail and governments stop inflating their national currencies in hopes of stimulating their economies. But that won’t happen until the U.S. and global economies “recover”—and when do you think that will be?
• If the previous reasoning is roughly correct, you can expect to soon see something never before seen: global hyperinflation.
In the past we’ve seen hyperinflation in the Wiemar Republic. Too bad for them, but the rest of the world (which still had asset-based monetary systems) wasn’t too badly affected. More recently, we’ve seen hyper-inflation in Zimbabwe. Too bad for them, but there was not enough of a contagion effect to topple the world’s other fiat currencies.
But if we see hyperinflation strike any of the major economies (US, EU, China, Japan, etc.), I suspect that we’ll see round after round of additional, tit-for-tat episodes of inflation in other major economies until all of the fiat currencies are rendered worthless and the whole world is left staggering in poverty and praying for the return of a gold-based monetary system or the return of the Messiah.
The fault, dear Brutus, is not in our stars, but in our fiat currencies.