EDITOR'S NOTE: The best way to introduce this next article is through analogy. Imagine being unable to spend any amount of money beyond what you hold in your checking or savings account. You’d probably agree this would force you to become financially responsible. Now, imagine having the option to take out virtually unlimited loans that you can transfer over to your children, meaning, they will be responsible for paying back your debt. The catch is that you’d have to convince them that this is a “normal” thing to do. Maybe they’ll do the same, adding on their contributions to the already snowballing debt load and transferring it to their kids (your grandkids). But what if they’ve reached a breaking point where they can no longer finance your debt or theirs? How might they react upon realizing the perversity of this system? When you think of our $30 trillion national debt, you can probably make the connection between the hypothetical story above and the reality of our current state of affairs—one that can potentially trigger a global monetary meltdown.
We are in the early stages of a global money meltdown. The money meltdown, mainly stemming from governments spending and borrowing irresponsibly, has been underway for some time. The pandemic and the sanctions on Russia have greatly accelerated the meltdown process, evidenced by the massive rise in inflation and the shortage of goods.
The interrelationships between national currencies, trade and production are very complex. Many books have been written on the subject. Therefore, the following is merely an outline of the situation and issues to be dealt with.
When the world was on the gold standard and free trade was the norm in the century before 1914 (the beginning of WWI), governments were limited by the system as to the amount of debt they could incur. With the movement away from gold to a U.S. dollar reserve standard, which took place from 1914 to 1971, when the last tie with gold was broken, the government debt discipline also was broken. Assuming an average economic growth rate of 2% to 3%, the U.S. could have run modest fiscal deficits (under 3% of GDP) and modest trade deficits forever. This characterized most of the period from the first Reagan administration until the pandemic when all fiscal discipline was thrown away and has yet to be reinstated.
The lack of fiscal discipline has caused a sharp rise in the ratio of government debt to GDP to more than 100%. Unless government spending and monetary growth are drastically reduced, the cost of servicing the debt will rise far faster than government revenue, resulting in accelerating inflation and eventually an economic collapse.
The sanctions imposed on Russia (reducing the supply of Russian commodity exports, notably oil and gas) add to global inflationary pressures. Part of the goal of the sanctions was to bring down the value of the ruble, which worked for a few days until the Russians started demanding that the Europeans (being characterized as “unfriendly” countries) pay for their gas with rubles or gold. Suppose the Europeans are forced to buy rubles. In that case, it will bid up the price of the ruble (the opposite of what was intended), and the Russians will be in the position of largely determining the price of the ruble in euros or other currencies.
The Europeans made a huge mistake by allowing themselves to become dependent on Russian oil and gas. The Biden administration has told them not to worry because the U.S. will provide them with the necessary gas in the form of liquefied natural gas. The catch is that it takes time to build LNG terminals to send and receive the gas, as well as the pipelines to and from the LNG terminals and the specialized ships to carry the LNG. The “greens” (in or allied with the administration) do not like fossil fuels and are likely to do everything they can to stop or slow down the necessary approvals. Those banks and others that supply the capital to build the pipelines, terminals and ships will not release the funds until the regulatory and legal uncertainties are removed. In fact, there is plenty of natural gas in Europe, which could be obtained by fracking — but the European “greens” have blocked it up to now.
The Russians made a mistake by allowing themselves to become so dependent on commodity exports and particularly gas sales to Europe, rather than building a diversified economy as China did. The Chinese, the Indians and others will likely buy more Russian commodities, but it takes time to build the necessary infrastructure. Most of the gas pipelines from Russian gas fields were constructed to serve Europe, not China, so there is a crash program to build new pipelines to China.
Even though most commodities — notably oil and gas — have been priced in U.S. dollars, the Russians will take Chinese and Indian currency for their commodities as long as they can buy sufficient goods and services from those two countries to cover the gas and oil sales. Russia, China, Iran and others have been working together to create a new reserve currency to wean themselves from what they perceive as U.S. dollar tyranny. This will take time and is not easily done.
The Chinese are in the best shape to weather the global monetary storm. Because of concerns over the rising tensions with the U.S., they have been stockpiling many basic commodities, including grains and other foodstuffs. But as global customers for Chinese products lessen — again, with inflation in the major currencies rising faster than real wages — it will dampen the Chinese economy.
As the global economic situation worsens, private individuals and institutions will create workarounds. Tax evasion will rise as governments fail to adjust tax rates fully for the rise in inflation. Various types of nongovernment money-like products, including crypto and commodity-backed currencies, will be created, some for a single temporary purpose to get around government taxes and regulations. Very sophisticated barter arrangements will emerge as a way of providing necessities and avoiding the foot of the government. The world will more and more resemble some American inner cities. The good news is — if you live long enough — at some point, people will say “enough,” and new, real leaders will emerge.
• Richard W. Rahn is chair of the Institute for Global Economic Growth and MCon LLC.
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Originally published on Washington Times.