A part of economics demands an understanding of money. Money as we use today is paper currency. It is often referred to as FIAT currency because after the Gold Standard was dropped by President Nixon in 1971 The US "declared its Federal Reserve Notes to be legal tender". The term "fiat" is a Latin word that is often translated as "it shall be" or "let it be done." Thus fiat currencies only have value because the government says it has value maintains that value; there is no utility to fiat money in itself. A friend once asked what backs the US Dollar, and more or less joking I said GUNS!
There is more than a joke in that it. But it may be more constructive to ask WHY people accept and use the USD. The answer is pretty simple and basic. People use the USD because they have confidence that it will be accepted by others universally so it can then serve as a reliable form of exchange ie money. Indeed, at present, the world accepts the USD. It is the World Reserve Currency. Many countries use the USD as their own currency or peg their own issues to the USD valuation. Other countries with strong currencies relatively speaking are Japan, Switzerland, the EU and others. People have confidence in these currencies too but the primary one is the USD. Currencies act like commodities and trade against each other so you can buy one USD with say .9 Swiss Francs...yes, that means the Swiss Franc is more valuable because it takes less than one SF to one USD. This fluctuates with various economic and political factors so an ebb and flow exists in the exchange rate between currencies. Many know this from traveling when their strong USD gets exchanged for a lot more of the local currency like the Mexican Peso ahs at times.
This writing is about that CONFIDENCE mentioned. Confidence changes with circumstances. The world stage is an active one with other countries vying for their own currencies to have the confidence of the people and China has their eye on the World Reserve Currency status for their Renminbi or Yuan. Right now the Yuan trades at about 16% of the USD value so it takes roughly 6 Yuan to buy one USD. This valuation and resulting exchange rate reflects the confidence people have in the Yuan and relatively in USD.
When backed by Gold, the USD didn't need governmental edicts to have value because Gold was a valuable commodity and people had confidence in it. It still is valuable and some still have that same confidence in it too. Paper needs something to back it and of course we've all heard it is backed by the FULL FAITH AND CREDIT of the US GOVERNMENT. Good article here: https://seekingalpha.com/article/145722-what-really-backs-the-u-s-dollar
But what if that "faith and credit" were to be lessened. Perhaps some event or series of events shakes the confidence of people using the USD. It's relative value could plummet. I personally believe we will see that sooner or later. My opinion on this is based upon the serious devaluation or dilution of the value of the USD by printing more and more money to keep the deficit spending and National Debt from collapsing the economy. Of course, economies are complex things so there are likely more factors that would play into lowered confidence. Among these is the government's policies and those in power making them. What is the current confidence in the Biden Administration and the its policies? From recent polls not too high. The question "Is the US on the right path" gets a majority NO. I'm a NO. That shakes confidence.
So as confidence in a country's direction wanes, it's currency follows. Maybe not immediately but it follows.
What could bolster confidence? A Balanced Budget, stopping the money printing, restoring a good sense of Law and Order, raising interest rates realistically... not .25 but much steeper like Paul Volcker did in those horrible Carter economy days. Actually, current inflation is as bad and in some ways worse so a strong interest rate hike is needed. That would bring some rough economic spots... what they call a hard landing. But going through it would show resolve in doing the right things and I think the USD would regain its confidence. Without these and other sensible restorative actions, I'm afraid the USD will slide. High inflation with a concurrent lower USD spells disaster for the working class and especially the poor and those on fixed incomes. It s already being felt.
Whether you have personal confidence or not isn't the driver. It is the specific confidence in the US and its direction that influences the world's confidence in the USD. When confidence goes, so goes the currency, so goes the country. And so goes the World Reserve Currency status. OUCH!
Best,
Donn Marier
DM-Your Own CFO