Hedge fund and forex titan Stanley Druckenmiller believes current Federal Reserve policy and U.S. deficit spending are setting the U.S. dollar on a path to collapse. This morning he told CNBC’s Joe Kernen that it’s “more likely than not” the U.S. dollar will lose its status as the global reserve currency within 15 years. Druckenmiller’s comments were focused on the Fed’s commitment to low interest rates and U.S. debt bond buybacks, moves that ultimately support U.S. deficit spending on coronavirus pandemic relief.
Druckenmiller’s comments were positive for one group already effectively shorting the dollar: cryptocurrency advocates. With the euro a basket case and the Chinese Communist Party-backed yuan still viewed with suspicion, Druckenmiller doesn’t see another fiat currency that can play the universal mediation role of the dollar anytime soon. Instead, he thinks “the most likely replacement” for the dollar would be a “crypto-derived ledger system.”
This is a remarkable set of statements from Druckenmiller, considered by some to be the greatest foreign exchange trader in history: He was the architect, among other big trades, of George Soros’ legendary shorting of the British pound in 1992. Now he’s echoing one of the most fundamental talking points of bitcoin advocates, who have for a decade contrasted the orange coin’s immutably fixed issuance with the propensity of states to let the money printer go brrr.
Inflation hasn’t been a major worry for the U.S. economy for decades – in fact, before the pandemic, the Fed regarded inflation as too low for nearly a decade. But pandemic spending has pushed the U.S. deficit and debt to record highs, causing widespread concerns about inflation risk. Inflation can be a major headache for dollar-denominated investors, since it erodes their holdings and gains. It can also be an annoyance for workers and consumers, though wages tend to inflate along with prices.
If the dollar becomes less attractive as a tool for foreign governments and global traders, the unwinding of its global reserve status could be downright catastrophic for pretty much everyone in the U.S. Somewhere between 40% and 72% of all U.S. banknotes are believed to be held abroad, and dollars make up over 60% of national foreign exchange reserves worldwide, according to the International Monetary Fund. If faith erodes, attempts to sell those positions could create a vicious downward cycle in the dollar’s value, which would have an array of negative impacts at home.
Despite clear longer-term trends in U.S. debt, it’s far from clear that right now is really the time to rein in spending. Druckenmiller argues that the ongoing U.S. recovery is so strong that further pandemic relief spending is unnecessary and even risky – but the relief spending appears to have been crucial to creating that recovery in the first place. In fact, some argue that the U.S. response helped it "win the pandemic" by compensating for broad collapses in demand. Some also believe pandemic relief headed off economic damage on par with the Great Depression, which could have damaged the dollar’s international standing as much as moderate inflation, if not more.
Druckenmiller doesn’t dispute the importance of relief spending, instead more modestly arguing that it’s time to wind it down. It’s a broadly Keynesian argument: Grow the deficit while the private sector is down, then scale back when the broader economy recovers. It’s also arguably Monday morning quarterbacking because current relief programs, some set to last another six months, were in the pipeline before the success of the U.S. vaccine rollout was certain. It’s even debatable on its current merits – the U.S. real unemployment rate (U-6) is still above 10%, for instance, suggesting there’s plenty more slack in the overall economy.
That’s just one of the big disparities in what inflation means at different income levels. As mentioned, it’s investors and the wealthy who generally have the most to lose from inflation, which eats into dollar-denominated returns while also diluting the value of dollars held. Meanwhile, it has been workers, who are less likely to have significant savings or investments, who saw the greatest proportional benefit from pandemic relief spending and who will suffer most when it ends. Druckenmiller’s reserve currency endgame scenario shows one way that irresponsible government spending hurts everyone eventually, but in the short run pandemic relief has made a lot of regular people’s lives much better than they would have been.
This is almost never acknowledged in broader discussions of inflation, but it’s clear to see if you contrast current inflation worries with responses to then-President Donald Trump’s 2017 tax cut package. The Congressional Budget Office estimated those cuts, which disproportionately benefited the rich, would contribute $1.9 trillion to deficits over 10 years, even accounting for added growth spurred by the cuts.
That’s just as big a budget hole as President Joe Biden’s American Rescue Plan created, but there was barely a peep about inflation following those tax cuts. That’s even more remarkable because the cuts came during a period of economic strength that made them, according to conventional thinking, economically unnecessary and even more likely to be inflationary than spending during a slowdown. Even more puzzling, many of the same people worried about pandemic inflation are simultaneously opposed to Biden’s attempts to partially reverse the Trump cuts.
This all points to broader challenges that could come with any multinational reserve currency, crypto-derived or otherwise. While inflation is rightly feared, deficit spending is an important tool for nation-states to meet local political and social needs, particularly protecting the most vulnerable members of a society during crises. In a worst-case scenario, a global currency that totally usurps national currencies would limit a national government’s fiscal discretion to take these kinds of actions. This can be seen in the problems nations like Spain and Greece have weathered after giving up their own currency to use the euro.
But for nations that retain viable national currencies, a supranational reserve currency might be more moderating than constraining, particularly if it was accessible to the general public. Right now, the main options if your own currency is being mismanaged are to look for other nations doing it better or to buy gold. But a neutral, anti-inflationary reserve layer could be a much better refuge. If it were easy to buy and hold (for instance, through a public blockchain), distrust in a government’s fiscal policy would be quickly punished via falling currency demand. Meanwhile, governments would still have the flexibility to issue debt denominated in their own currencies when it was truly needed and supported by public sentiment.
But it’s hard to see a path there that doesn’t involve serious disruption for the dollar and the U.S. as a whole. The $1.9 trillion in pandemic spending, after all, was added to an existing mountain of government debt to reach the current total of more than $28 trillion. If waning faith in the dollar translates into less global appetite for holding that debt, Druckenmiller says rising interest rates could require as much as one-third of the U.S. annual budget be paid out in interest alone, from roughly 10% right now. That would be bad for just about everybody.