"Every perception is to some degree an act of creation, and every act of memory is to some degree an act of imagination."
-- Gerald Edelman, Second Nature: Brain Science and Human Knowledge
2 The Capital War4 The Capital WarThe Capital WarChapter 7: US-China Relations and Wars2020-10-18Journal
The United States is testing the limits of how much there can simultaneously be a) enormous amounts of dollar-denominated money and debt created, b) falling and negative real returns, c) the dollar being used as a weapon (e.g., the usage can be limited via capital controls), and d) a fiat monetary system. We won’t know what the limit is and we can’t say it is here until it is reached. At that point it will be too late to fix. From both my studies of past historical extreme cases in which these conditions existed and from our analysis of current and upcoming supplies and demands for US money and debt, one can see that the US government, the Federal Reserve, and the buyers of the debt are testing the limits of how much money and credit can be squeezed out of a reserve currency without breaking it. From speaking to the most knowledgeable people in the world in this domain, including those who are now running the world’s monetary and economic policies and those who did in the past, there isn’t a single person I spoke with who when shown the evidence—i.e., both the historical cases in relation to the current case and the current picture of the supplies and demands for dollar-denominated money and debt—disagrees that we are in unprecedentedly risky territory and testing the limits of what’s possible. That doesn’t mean that anyone is confident that the dollar will decline significantly in value or as a reserve currency in the near future. The picture for the dollar and dollar debt is like (and related to) the picture for interest rates. If a few years ago you had asked whether these extremities would be reached—i.e., whether we would have negative nominal and real long-term interest rates with debts and borrowings so large in a capital market that governments aren’t imposing capital controls on to force such circumstances—all these knowledgeable people would have said “implausible.” That is because that never happened before and because it is tough to figure out why holders and buyers of that debt would accept that deal rather than move their wealth into other things. One would have looked at past extremities when the largest budget deficits and debt monetizations existed in such large amounts and interest rates stayed low (which were war years when government capital controls were required and interest rates were targeted) and looked at the most deflationary and depressing economic times, and one would never have seen these things happen, so “implausible” would have been a smart assessment. Yet that is what has happened.