We have two banking systems, the official banking system and the shadow banking system. The official banking system runs on dollars, the shadow banking system runs on collateralized debt and other derivatives that trade as if they were dollars, I will call those derivatives shadow bucks. The reason dollars increased in value (which many people, myself included, didn’t expect) is due to what I call a “hyperinflation” of shadow bucks. The value of shadow bucks collapsed (as the housing and credit bubbles burst) causing prices measured in shadow bucks to soar. As any intelligent Zimbabwean with Zimbabwe dollars has already demonstrated, when the value of your money collapses you find alternate forms of money. Zimbabweans fled to US dollars, so did the holders of shadow bucks. The effect may not have been that significant if it weren’t for the size of this market — I didn’t appreciate the extent to which the shadow banking system dwarfs the official banking system. The buying pressure from economic refugees overwhelmed any other consideration.
Here is where it gets interesting — despite the collapse of shadow bucks, the shadow banking system still dwarfs the official banking system. That means the process of people fleeing to dollars could continue longer than many first assumed. Or conversely, it also means there is a time limit. At some point, should the shadow banking system fail completely or the economy recover and assets reverse direction, there are no more economic refugees from the shadow banking system and the bid currently supporting the dollar market disappears. But more importantly, should the flow of refugees continue, there is also no fixed reason these people must trade their shadow bucks for US dollars. They could just as easily buy any other currency or form of money. So in trying to determine whether the US dollar will withstand inflation and quantitative easing without collapse, the question is reduced to whether the supply of refugees will continue and whether they will continue to choose US dollars.
Here is where it gets really interesting — given the extent to which the shadow banking system still dwarfs the official banking system, you would be shocked to know the extent to which the official banking system dwarfs the gold market. If even a few players drop some pocket change into the gold market, the price will soar. There is no guarantee this will happen, but there is also no guarantee they will buy dollars. The problem with forecasts in our current state is that we no longer have free markets, we are largely gambling based on the future decisions of powerful people we have never met. All we can do is guess, but the reality of our current global economy is that many other currencies are equally challenged, if not more so. The best alternative to US dollars as a means for savings and exchange, anywhere in the world, should the need for an alternative arise, is gold.
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