What would be required for the US dollar to collapse? This question has been debated for years. Although a currency crisis in the United States might appear plausible on the surface, it is highly unlikely.
Currency collapses. Whenever a system collapses, a lack of faith in money’s stability or usefulness as a store of value or medium of exchange is at the root of the problem. A currency is in trouble when users stop believing that it is useful. Various factors contribute to this, such as improper valuations or pegging, chronic low growth, or inflation.
The strength of the US dollar
To understand its strength, we must first examine the Bretton Woods Agreement. At a 1944 conference of Allied nations, the Bretton Woods agreement was forged. In it, it stated that purchasing currency would lower its supply and increase its price. The central bank would print more currency if the price of a currency increased too much.
The U.S. dollar has supported the value of other major currencies since the Bretton Woods Agreement. As a reserve currency, the dollar is seen as more legitimate by domestic users, currency traders, and participants in international transactions. Despite being the most prevalent reserve currency in the world, the U.S. dollar is not the only one. Four other reserve currencies have been approved by the IMF as of March 2022: the euro, the British pound sterling, the Japanese yen, and the Chinese yuan.
The United States economy remains the world’s largest and most influential economy. Despite a significant slowdown in growth since 2001, the U.S. economy continues to outperform its peers in Europe and Japan.
Dollar’s weakness
The fundamental weakness of the U.S. dollar is that it is only valuable through government fiat.
In the 1970s, it was considered a rather radical concept. In the absence of a commodity-based currency standard (such as gold), governments might print too much money for political purposes or to conduct wars.
One of the reasons the IMF was established was to monitor the Federal Reserve and its commitment to Bretton Woods. In the present day, the IMF uses the other reserves to discipline the Fed. In the event that foreign governments or investors decide to withdraw from the U.S. dollar in large numbers, the flood of short positions could significantly hurt anyone with assets denominated in dollars.
If the Federal Reserve creates money and the U.S. government assumes and monetizes debt faster than the U.S. economy grows, the future value of the currency could fall in absolute terms. If the dollar falters in absolute terms, it may still be stronger globally due to its relative strength.
Therefore, the question arises. Is the US Dollar going to collapse?
There are possible scenarios that could lead to a sudden crisis in the value of the dollar.
The most realistic scenario is one in which both inflation and debt are high, leading to a sharp rise in interest rates by the Federal Reserve.
Since a large portion of the US national debt is composed of relatively short-term instruments, a spike in rates would resemble an adjustable-rate mortgage after the teaser period ends. Should the United States struggle to meet its interest payments, foreign creditors could dump the dollar, triggering a financial crisis.
It is possible for users to leave the dollar if the U.S. enters a steep recession or depression without dragging the rest of the world along with it. Another alternative would be for some major power, like China or Germany after the end of the European Union, to reestablish a commodity-based standard and monopolize the reserve currency market. Even in these scenarios, it is not clear whether the dollar would necessarily crash.
Furthermore, even if the United States were to default on some debt obligations, there is not much evidence that the global economy would allow the dollar to collapse. The risk of contagion would be substantial.
