Could the Dollar's Collapse Prompt a New Currency?

A large and growing trade deficit with China under NAFTA threatens a dollar decline that could well set the stage for the emergence of the Amero as a unified North American currency.

In 2005, the U.S. balance of trade deficit with China was $201 billion, a 25% increase over 2004. In 2006, China’s foreign exchange reserves topped $1 trillion, a staggering amount considering that before 1979 China’s foreign exchange reserves had never surpassed $1 billion. Approximately 70% of China’s foreign exchange reserves, some $700 billion, are held in U.S. dollars, about half of which are invested in long-term Treasury bonds that in turn fund our federal budget deficits. Prior to Thanksgiving 2006, China’s central banks suggested a possible move to diversify foreign exchange holdings away from the dollar. As a consequence, the dollar sold off on world currency markets, hitting a new 20-month low against the Euro, a currency which is beginning to compete with the dollar as an international foreign reserve currency.

In the recent top-level cabinet officer meeting held in Beijing, U.S. Treasury Secretary Henry Paulson said that China had pledged to allow a greater extent of rate flexibility on the Chinese RMB (the Yuan), but refused to give a timetable for achieving that objective. Since July 1, 2005, China has allowed the Yuan to fluctuate within a narrow range, pegged to a basket of international currencies. Still, China has consistently refused to allow its currency to float freely on international currency markets. In his Beijing speech, Federal Reserve Chairman Ben Bernanke’s prepared text accused China of maintaining an undervalued currency on purpose, in order to provide an effective subsidy to Chinese firms that export their goods. In delivering the speech, Bernanke decided to moderate this criticism, noting only that a stronger Yuan would reduce “the incentive for Chinese firms to focus on exporting.” The December 2006 cabinet-level meetings in China showed progress, but no definite results.

Meanwhile, on December 15, while Paulson was in China, the Treasury issued the 2006 Financial Report of the United States as released by the U.S. Department of Treasury, which reported that the 2006 federal budget deficit was $4.6 trillion, not a previously reported $248.2 billion. The difference is that the typical Treasury Department report of the federal budget deficit is on a cash basis where all tax receipts are applied when received to current liabilities, whereas the Financial Report of the United States is calculated on a GAAP basis (“Generally Accepted Accounting Practices”) accruals are made for current year changes in the net present value of unfunded liabilities in social insurance programs such as Social Security and Medicare. The report also showed that the GAAP accounted negative net worth of the federal government has increased to $53.1 trillion, while the total federal obligations under GAAP accounting now total $54.6 trillion, taking into account the present value of future Social Security and Medicare liabilities. Put simply, the 2006 Financial Report of the United States shows that arguments that the U.S. government is bankrupt have increasing merit.

Currently, we are experiencing an inverted yield curve in which long-term interest rates are lower than short-term interest rates, a condition that many economists feel predicts slower economic growth in the first half of 2007. The U.S. GDP grew at a rate of 2.2% in the third quarter 2006, the weakest pace since late 2005. If the housing market bubble bursts in 2007, the U.S. could experience an economic slowdown in 2007. Facing continuing trade and budget deficits in 2007, the task before Treasury Secretary Paulson is how to engineer a gradual dollar decline rather that an abrupt drop in value that could signal a dollar collapse.

Meanwhile, Robert Pastor of American University gave an interview in Spanish in October 2006 in which he suggested that a 9/11 crisis might be just the type of catastrophe needed to overcome governmental inertia in advancing the type of economic integration necessary to form a North American Community. In a subsequent interview, Pastor affirmed that the Spanish interview did represent his thinking. “What I’m saying is that a crisis is an event which can force democratic governments to make difficult decisions like those that will be required to create a North American Community,” Pastor said. “It’s not that I want another 9/11 crisis, but having a crisis would force decisions that otherwise might not get made.” As we have previously documented, Robert Pastor, who we have called “The Father of the North American Union,” has provided much of the intellectual justification behind the push toward a merger between the U.S., Mexico, and Canada.

Paulson, in China, displayed customary confidence that any dollar devaluation could be handled gradually, on a systematic basis. Yet, the cabinet-level summit meeting ended with no concrete plan in place that shows promise of slowing the growing trade deficit with China. How strong will the dollar be when China holds $2 trillion in foreign exchange reserves, of which $1.5 trillion is held in U.S. dollars?

Nor, with the 110th Congress beginning in January 2007 with a Democratic majority, do we have any reason to believe we will see a sudden return to fiscal discipline in spending and entitlement programs. The Democrats systematically defeated President Bush’s attempt to put the issue of Social Security reform on the table following his 2004 re-election victory. How huge will deficits in the GAAP accounted federal deficit budgets be if Hillary Clinton should become president in 2008 and succeed in adding universal health care to the Social Security and Medicare liabilities we are already accruing.

So far, we have been managing huge and growing double deficits in the federal budget and our trade balances by cash accounting in the federal budget. Still, we have not reserved anything for the present value of future Social Security and Medicare payouts accruing now. A solution to paying huge future obligations would be to monetize the debt, allowing the dollar to drop in value dramatically, so future liabilities could be paid off in dramatically devalued dollars.

What Robert Pastor suggests is that in the event of a national crisis, such as could be envisioned in a sudden dollar collapse, we will experience another push toward North American integration. In the process of revaluing into a new North American Community currency, all three countries could take the opportunity to recalculate future unfunded government obligations in the value of a newly defined unitary monetary unit.

Prior to 9/11, surrenders of individual freedoms such as we have witnessed in the Patriot Act would have been unimaginable. In a fiscal 9/11 crisis triggered by a dollar collapse, Dr. Pastor could well be right. The Amero might then look reasonable, under the argument that we will need continental resources to compete with the Euro as a reserve currency and with the Yuan, especially when China seems resistant to a freely floating currency.