Famed Austrian economist Ludwig von Mises wrote in his seminal work, Human Action: A Treatise on Economics (originally published by the Yale University Press in 1949), that:
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
The collapse of a historic credit bubble occurred in 2008. However, despite years of further credit expansion, "a final and total catastrophe" of the U.S. dollar system has yet to occur. While an inflationary U.S. monetary policy has serious consequences, hyperinflation is not an immediate result. There are three general ways in which the U.S. dollar system could break down:
(1) rejection of the U.S. dollar as the world reserve currency
(2) as an eventual consequence of U.S. federal government insolvency
(3) a domestic failure of confidence.
Of the three, U.S. federal government insolvency is the most serious because it would result in both the loss of the U.S. dollar's world reserve currency status and also, in a failure of domestic confidence. However, a new threat to the U.S. dollar has emerged, which could trigger a hyperinflationary collapse before the U.S. federal government's finances become unworkable -- e.g., when debt service begins to crowd out military and Social Security spending. Specifically, the perceived legitimacy of the U.S. financial system has not merely been tarnished by recent scandals, but is in danger of collapsing. The consequences of a domestic breakdown of confidence and trust in the U.S. financial system cannot be overstated.
World Reserve Currency Status
The most commonly cited challenge to the U.S. dollar system relates to its waning status as the world reserve currency. The BRIC countries (Brazil, Russia, India and China), along with South Africa, no longer use the U.S. dollar for trade settlement amongst one another. The Chinese have internationalized the renminbi (RMB), which is now used in trade settlement with the other BRIC countries, as well as with Australia, Japan, the United Arab Emirates (UAE), Iran and various South American and African countries under bilateral agreements. Iran, which is the world's fourth largest oil exporter, has refused to accept U.S. dollars in exchange for crude oil since 2009. While European countries utilize the euro, South American countries have instituted a local currency payment system -- the Sistema de Pagamentos em Moeda Local or SML. At the same time, the IMF stands ready to settle international trade using Special Drawing Rights (SDRs). However, local settlement at the regional level is largely irrelevant.
At the global level, the implicit crude oil backing of the U.S. dollar by the Organization of the Petroleum Exporting Countries (OPEC) remains in place, and the U.S. military remains dominant. As long as OPEC backs the U.S. dollar, and as long as there is no viable challenger, the U.S. dollar is unlikely to be deposed. The euro, for example, is a troubled currency, and its future is questionable. China's economic ascent is likely to continue and the RMB can be redeemed for Chinese-manufactured goods. However, the Chinese economy is currently in a recession, the RMB is not a fully international currency, and China's military is not ready to take on the role of a global superpower.
At present, no national currency stands as a viable challenger for the position held by the U.S. dollar, and there is no consensus regarding its eventual replacement. However, discussion of the gold standard has moved from the fringes of the financial world into the mainstream. The price of gold has risen in response to widespread currency debasement -- i.e., as a hedge against inflation.
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