I am sitting here looking at a twenty dollar bill. At the top, it says Federal Reserve Note. I’m sure you have seen that before, but did you ever really think what that meant?
According to my dictionary, a note is a debt, a promise to pay ‘on demand’. Federal Reserve Notes (FRNs) are not backed by anything tangible like gold or silver. The only thing that makes them valuable at all is the faith people have that they can be traded for something else that they want, like food, a power drill, a ticket to a movie, etc. To put it bluntly, it is the American people themselves who back the currency; the blood sweat and tears of each of us. The word for this kind of money is ‘fiat’ currency. Essentially, a FRN is an ‘IOU’. But what if there is nothing available to trade those FRNs for?
Everyday, people purchase foreign goods at their local stores, and pay with US currency. That US money then goes overseas and is quietly accumulating in some huge imaginary shoebox called China’s foreign reserve, or Japan’s foreign reserve. China now has a trillion American IOUs in their shoebox and sooner or later, they are going to want something real for all those IOUs. What exactly can they trade them for? By my calculations, China, Japan, Taiwan, and Russia are holding some 2.3 Trillion dollars. To get an idea how much that is, a trillion is roughly $3300 for each man, woman, and child living in the USA. So 2.3 Trillion comes just shy of $8,000 per person. So a family of 4 has $32,000 worth of IOUs outstanding against them. To me, that is very scary, as that also means that 99% of Americans would be technically bankrupt if those IOUs were called in.
Now this situation would not be nearly so bad if American’s still made anything real. But we have systematically destroyed our manufacturing sectors in favor of service industries. Foreign countries are not going to buy life insurance or window washing services, or pizza delivery from the USA. These are valueless to them. They will want something real, and the only thing we have real in quantity is real estate, or minerals, coal, and food products like grain.
This is the big danger when trade between countries is not balanced. If the US were exporting goods at the same rate as we import them, then a foreign country could simply buy back their own currency with their reserve of our currency. Instead, they must spend their reserve on hard tangible goods, which more and more means our real estate, our resources, our food supply, and our capital equipment. In doing so, the increase in the amount of circulating money will cause the price of all goods to rise. This new inflation then decreases the wealth of every citizen as inflation always does.
I know I have simplified a lot here, but the mechanism is what it is. When we go to Wally World and buy a pair of tennis shoes from China, we haven’t paid for them until China has spent the money we just paid on US goods. Since our trend is to make less and less goods here that are affordable, and desirable, they are likely just to keep stuffing our bucks in their shoebox, until they have enough to buy our entire country at fire sale prices.