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What would happen if the USD collapsed?

Chris Laird
Jun 26, 2006

This paper looks at some kind of estimate of the economic losses/damages the world would incur if the USD went to zero next week. The conclusion is that it is inconceivable that any world central bank would ever even think of allowing a total USD collapse because of the financial and economic Armageddon that would follow for every nation in the world regardless of how much they like or hate the US and the USD...

Since World War 2, the USD has become the de facto world reserve currency. Right after WW2, the US had accumulated well over half the total world gold because of WW1 and WW2 arms sales to allies much of which were paid for in Gold initially. Of course, we know that the US then went to a 'Lend-Lease' policy of outright arms gifts to allies as WW2 progressed.

But After WW2, the world economies were destroyed and the USD was allowed to become the de facto world currency because we had accumulated so much gold. The other nations decided in the Breton Woods agreement to fix their currencies based on a 'gold dollar'. Until 1970, this was a de facto gold currency until Richard Nixon closed the gold convertibility of the USD. The effect was, and is, that most of the world's wealth today is inextricably tied to the USD.

At that time, the penetration of the USD worldwide was so vast that the world economy continued to base all prices of commodities, and prices, on the USD. Basically, even though the US had taken the USD completely off the gold standard, the financial mass and utility of the USD in the world economy was so powerful that the USD remained the de facto world reserve currency.

Basically, the vast majority of the world's wealth is now inextricably tied to the USD. This means that world central banks will not willingly permit its uncontrolled collapse. But there is another alternative which will be looked at in the end of this piece. That is an unforeseen or accidental financial meltdown that destroys the USD anyway.

A US treasury official in the 1970's talked to a world central banker about the banker's complaints that the US had a free ride, and was taking advantage of the de facto USD world currency standard. The Treasury official's response?

"Hey, it's our dollar, but its your problem!"


No doubt the world is reliving that conversation at this time. China, Japan, Russia, the Middle East oil kingdoms, Korea, Taiwan, and all the other major industrial powers of the world today are locked in a no win situation of having to take USD's for all their goods, and having to allow the US to run ruinous fiscal and trade deficits. They really have little choice because every industrial and commercial process from banking to making TV sets is cost based in USD and paid for predominately in USD.

To get to the point:

What would happen if the USD system collapsed?

Wouldn't every industrial process, banking transaction, retirement fund, manufacturing process stop dead for a time?

Wouldn't that mean that the world economies would have to endure a major depression and financial collapse because the oil in the world financial machine (the USD) ran dry?

Wouldn't there be massive shortages, as just in time manufacturing for everything under the sun stopped cold because the USD financial payments for everything from commodities inputs to worker paychecks, to truck drivers, to fuel payments for trucks became worthless?

Would the world have to find a new way to clear every financial transaction from a paycheck to even a box of pencils for a factory? Find out how to clear the entire mass of USD transactions that encodes every thing that is made, paid, invested - every second everywhere...

I.e. if the USD collapses the entire world economy stops cold. And then consider the fact that just in time manufacturing means that the entire supply of every thing has about 3 days inventory, and if factories have trouble making payments to suppliers for example, the factories have to stop, and 3 days later, there just aren't any more critical 'XXX' (you fill in the blank).

Imagine every USD denominated bank account becoming worthless. Imagine trillions of dollars of retirement funds becoming worthless. Imagine China losing 2/3 of its trillion dollar foreign reserves - and Japan, and Russia, and Taiwan, and Korea.

I have tried to guesstimate the total amount of USD denominated wealth in the world. IE the total amount of everything that has become irreversibly tied to a USD since Breton Woods:

If you were only to look at just the US - USD cash out, something like the old US M3, that figure is around $11 trillion. Then add about oh $3 trillion of USD cash foreign reserves in places like China and Japan. Of course, some of that is double counted because some of it would be considered in the old M3 figure (the old M3 figure is all USD cash and quasi cash the US has outstanding, including things like money funds).

But these figures - about $14 trillion are a small fraction of the real amount of USD assets. To really get an idea of this figure, we need to include the total value of the US stock market. Total value of the US mutual fund industry. Total value of USD denominated insurance outstanding. Total value of much of the commodities valued and the commodities exchanges and commodities trade.

I'm just broad brushing this. Also include the total value of USD loans outstanding in Real Estate if you really want to boost the calculation. Also include the total amount of USD treasury bonds. Also include the total amount of USD denominated derivatives!

General stab at listing the above:

USD real estate loans: $50 trillion
USD bond universe: $50 trillion (wild guess)
USD derivatives of every type: $300 trillion
USD valued/contracted commodities outstanding $50 trillion
USD financial instrument universe outstanding $100 trillion
USD financial obligations of the US Federal government $50 trillion

Now, this is all very broad brush and rough. But this all comes to a cool

$600 trillion.

I guess I have missed about half of everything because this listing would really be about 5000 pages. I just picked some of the big items. SO let's double this figure:

$1200 trillion of USD denominated and irreversibly connected world assets and money.

All this linkage was created mostly since Breton Woods in 1944 which was created to keep cash from draining/rushing out of Europe in World War 2.

Now I want to do another modification. These values are all only the static value of these amounts. To really get an idea of what wealth would be lost to the world if the USD totally collapses, we need to include something like a capitalization for the lost yield on these assets while the world figured out how to replace the USD with some other system.

If I capitalize $1200 trillion dollars at a very conservative 5%, for say a very conservative 10 years merely to try to get back to where we were just before the USD collapsed, we have to include another 50% on top of that figure, and I am not even amortizing.

SO add at least another $600 trillion.

Now, finally, we need to look at the incalculable value of what a real world reserve currency does for financial and manufacturing efficiencies. I would say that these efficiencies the world relies on for all its business and transacting would be at least 1/3 more of the total value of the whole thing. This is probably one of the more vauge things I am including in this calculation. That component comes to:

Another $400 trillion.

Grand Total: $2200 trillion

If these calculations make your eyes glaze over, imagine what it is doing to the world central bankers!

"the USD is our currency but it is your problem" indeed.

Ok, let's put this whole thing into perspective: If the USD collapsed to zero tomorrow, the entire world economy would stop cold, and the total loss to world wealth would be something like $2200 trillion over a period of ten years. I think this is a low estimate actually.

It would take the US with a GDP of $14 trillion a year 157 years to replace all that wealth.

It would take the world with a GDP of about $50 trillion a year 44 years to re create all that wealth.

And of course how would the US or the world earn all that back if the world economy stopped cold for about ten years in the mean time till they came up with an alternative to the USD?

This may all sound preposterous. You know, the idea that so much world wealth would disappear if the USD were to go to zero like that. However, I would like to point out that there is an event we can look at that has comparable type factors in the above calculations, not due to a currency collapse but in terms of the economic losses incurred.

That would be the Great Depression of the 1930's.

In that depression, the US and most financial markets lost about 90% of their entire market capitalization. They lost about ten years of GDP, in the case of the US alone the lost GDP was about 30%. Many other trading nations with us in that time lost more than 50% of their yearly GDP because so much economic activity stopped.

Hundreds of millions of people world wide literally starved for ten years, and also did I mention that WW2 cost the world about 100 million casualties, and that war had lots of its causes directly related to the Great Depression and the social and international stress it created.

Then calculate the hundreds of trillions of USD losses of capital, plants, and destroyed cities from that war, and we have a definite analog to the kind of scenario I just played out in my estimate of the economic damages / losses that would come from a USD collapse.

In short, literal and real world financial Armageddon. The US would not be the only loser.

We have already seen such kinds of losses of such magnitudes before less than 80 years ago!.

So don't think this is so way out there because it is not way out, this stuff happens!

Now, I have to make one final observation. People think that world central banks would be the ones to sell/kill off the USD, IE that is the only way it can be wiped out. The scary reality is that they may not be able to stop it from happening if they wanted to stop it. The fact is, a financial accident of market dominoes could easily cause a panic rush out of the USD. In the great depression, there was flight into the USD. This time, if there is a big worldwide financial collapse/panic, there will likely be flight OUT of the USD... The central banks might easily not be able to stop a real USD panic even if they tried concertedly.

I have written again and again that your retirement funds and investments are probably mostly in USD assets, and are subject to vaporization if a major world financial accident happens, central banks or no central banks. This might not happen for years. But we are definitely on the precipice of it.

My newsletter, the Prudent Squirrel newsletter, is a macro gold and economic analysis. It is one of the few that actually makes macro gold and precious metals analysis its major method. I have successfully predicted many major trend changes in the financial markets, the most recent was the call about two weeks in advance for gold's 150$ correction for subscribers. Prediction is not a goal of the newsletter, but I do make some, particularly when there are major economic/gold sea changes coming that I foresee.

Chris Laird
Editor in Chief

The Prudent Squirrel Newsletter is a big picture gold and economic commentary. Stop by and have a look.

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