CHAPTER 14

DIARY ENTRY: October 25, 2046 – The Sneaky Setup

Why couldn’t the US continue borrowing in 2025, to avoid defaulting? If Uncle Sam had not defaulted on the payment to the Reserve Account, other nations would not have rushed to sell the notes they held. Borrowing would’ve then continued peacefully, as it had for nearly a century.

In 1944, when WWII was winding down, forty-four countries met at a hotel in Bretton Woods, New Hampshire. The sprawling, white hotel resembled a European palace. The red roof distinguished it from the green woodlands, and Mount Washington rose majestically behind it. They discussed a new international monetary system. The US dollar was voted as the world’s reserve currency, meaning the central bank of each country would hold its extra savings in US dollars. The US had the largest gold reserve, and the US Treasury agreed that any central bank could exchange dollars for gold at any time. Dollars were as good as gold. Countries also voted for the dollar, because the US was an economic powerhouse and had a strong military. The dollar took the throne from the sterling pound.

In the 1960s, Switzerland and France noticed that the US was outspending its gold reserves and increased their requests for gold. In 1965, President Charles de Gaulle of France sent his navy across the Atlantic to pick up the French reserve of gold and was followed by several countries.[1] The US was running out of gold. In 1971, President Nixon announced that the US Treasury would temporarily suspend exchanging dollars for gold. He unilaterally and without notice ripped up the Bretton Woods Agreement. In 2015, this suspension was still in effect.

Without gold, the demand for the dollar was at risk. So in the early 70s the US cut a deal with Saudi Arabia and later OPEC.[2] The US would provide military protection, if Saudi Arabia would sell oil only in dollars. This deal created a new demand for dollars. Most nations needed oil for vehicles, so they needed dollars to buy it. Because dollars depreciate over time, these nations wanted US notes instead. Since the US could borrow using notes, it could minimize its revenue from income taxes. If my taxes as Joe American are low, I have extra money to buy new cars, live in large houses, and take lavish vacations. So the deal with Saudi Arabia protected my high standard of living. If that arrangement with Saudi Arabia ever changed, my standard of living would drop. The main reason Obama opened US doors to Syrian refugees in 2015 was that Saudi Arabia demanded it.[3] Saudi Arabia impliedly threatened to sell their oil not in dollars.

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Since about 2009, China has been planning a coup for that same throne, hoping to replace the dollar with its own currency, the yuan. (Renminbi is the name of the overall currency, and yuan is the basic unit like a peso or euro.)[4] In that year the governor of the Chinese central bank published an essay on its website, calling for the dollar to be removed as the international reserve currency. [5] China greatly increased its gold reserves. In 2013 the EU was China’s largest export market. That year the Chinese central bank signed a deal with the European Central Bank to trade in yuan and euros (instead of converting those currencies into dollars first for this international trade).[6] In 2014, China then signed an Agreement on Cooperation with Russia also to trade in non-dollars, and then immediately afterwards entered into a thirty-year gas contract with Russia. The Chinese were trying to foster international confidence that it’s okay to trade in their currency rather than the dollar.[7] Also in 2014, China petitioned the International Monetary Fund to accept the yuan as one of its few reserve currencies. [8] If the IMF would adopt it, then nations might do the same. In late 2015 the IMF approved the yuan as a reserve currency, adding it to the elite basket of the US dollar, euro, British pound, and Japanese yen.[9]

As said, China started hoarding gold like a hungry dragon. Remember, the US had the largest supply of gold in 1945, when the dollar became the primary reserve currency for the world. In the 1970s the US had about 8,000 tonnes of gold in Fort Knox, which hasn’t really changed since then.[10] In 2015, China announced it had about 3,718 tonnes in its central bank and other state-owned banks—so, about half.[11] (This amount had nearly doubled since its announcement in 2009.) Gold experts suspected that China secretly had more, which turned out to be true.

Well before 2015, China had formed a special military unit charged with finding and mining gold within its borders, the only military unit of its kind worldwide.[12] Notice the advantage. Extracted amounts could be hidden from public view. If the Chinese central bank instead had been purchasing it from private mining companies within Chinese borders, those transactions would be measurable. By 2015, China had become the world’s largest producer of gold.

During this same time period, the Chinese were also buying and importing gold in huge volumes every year. To hide again the amounts being deposited in its central bank, the Chinese government actively encouraged its citizens to buy some of this gold, thereby masking how much went to the bank versus to its population.

Sneaky. Sneaky. Why so sneaky? China didn’t want the US to know the amount, because the US would have then increased its own supply. Instead of a nuclear arms race with the Soviet Union, the US would’ve had a gold accumulation race with China.

In 2025, China announced that its central bank and other state-owned banks had a larger cache of gold than the US. This shocking supply encouraged most other countries to adopt the yuan as the primary currency for international trade. But having gold was not enough to achieve that.

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Lending large sums of money to the US was a setup, a planned step in the coup. With the lending to the US Treasury, Uncle Sam could pay his bills without raising taxes. Joe American then had extra money to buy Chinese goods. Indeed, most of the goods Joe American bought for his home were manufactured in China. Joe was fine with that. Chinese lamps and spatulas turned out to be pretty sturdy.

Factories in China grew and also sold goods to other nations. In 2014, Chinese exports totaled 2.2 trillion dollars, whereas US exports totaled 1.6 trillion.[13] Meanwhile, American factories diminished. From 2001 – 2010, an average of fifteen factories closed per day. In some years the daily average was four and, in other years, twenty-three per day.[14] China had to appear nervous about the growing US debt and that Chinese loans were at risk of not being repaid, so China would occasionally dump a small portion of US treasuries on the open market.

Then in 2025, China quit lending. Gotch ya!

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In that year, Uncle Sam still needed to borrow to pay all his expenses. His revenue was short by twenty-one percent. He needed to borrow over a trillion dollars.[15] There was no way for him to increase revenue and reduce spending for him to close that huge gap. Sh!t. The US could not simply regain all the factories that closed in favor of Chinese factories. Panicking, he tried to characterize China’s bankrupting of America as an act of war, and tried to prejudice the world against China.

But the economic minister of China drew attention to Russia in 1998. The Russian government under President Yeltsin went bankrupt, when its deficit was high and the Paris Club quit lending. The Paris Club consisted of government creditors, who lent money to the Soviet Union when it needed it. In 1996 the Paris Club was willing to restructure its debt, but not lend more money. A year before the Russian default, a group of commercial bank creditors, called the London Club, had also lent money to the Soviet Union. They too were willing to restructure their loans but not lend more.[16] Both Clubs were unwilling to lend further, when Russia’s deficit was 20% the year before its default, and where that deficit was 3.2% of its GDP. Its national debt was as high as 50% of its GDP.[17] That was enough for those government creditors and commercial banks to lose confidence that they would get repaid if they lent more. Those figures represent a tolerance limit for a lender.

In 2025, these percentages were nearly identical for the US. America’s deficit was 21%, and its deficit was 3.8% of its GDP (even worse). Our national debt was 77% of our GDP (much worse). “If the Paris Club behaved this way, why shouldn’t China?” the economic minister of China argued. “That’s just what lenders do.” The Chinese sold their behavior successfully to the world as that of a nervous creditor. Uncle Sam could not rally the support he needed to pressure China into lending more through the sale of his Treasury notes.

So Uncle Sam defaulted. Japan and every other major country across the globe rushed to sell their US Treasury notes. Their central banks held huge reserves of these notes. But nobody on the open market wanted them except for a pitiful price. As with me, the US could not offer the excessively generous terms necessary to sell new notes. Borrowing this way dried up almost instantly.

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Yes, China lost four trillion dollars by holding valueless US treasuries.[18] But it was worth it! In 2025, the yuan gained the throne, ousting the dollar. The yuan was now the primary reserve currency held by central banks across the globe. That position was worth far more than four trillion dollars over the next century. As did the US over the UK in 1944, China had more gold than the US and more than any other nation. As a manufacturing giant, its economy surpassed the US. In that same year of 2025, China declared that all its exports must be purchased in yuan. Not only was the yuan backed with a hard asset, but China had successfully created a need for its currency. French importers of Chinese goods now needed yuan, which meant that the French Central Bank had to keep plenty as a reserve currency.

How could being the world’s reserve currency really be worth losing four trillion dollars? “I don’t buy it,” you say. Allow me to explain. Bear with me as I briefly define a couple concepts.

For purposes of understanding the global money model, you should think of US dollars as a commodity, i.e. a good, like a car or can of beer. Think of currency not as something you buy goods with, but rather a good you trade for another good. A person trades dollars for cars. Trading is bartering, not purchasing.

In 2015, when an importer in India bought tequila from Mexico, it used US dollars. Odd because neither nation’s currency was dollars (rather rupees and pesos). But using dollars was common for most trade between nations.

Where would India’s importer get large quantities of dollars to buy tequila? From the central bank of India, exchanging rupees for dollars. Thus, the central bank of India had to hold lots of dollars in reserve. It had to for the tequila importer and the importer bringing in Russian vodka and the one bringing in Malaysian clothes. The central bank needed dollars available for most of India’s companies importing goods. The same held true for the central bank of Brazil for most Brazilian companies importing goods. Since importers in nearly all countries around the globe traded using dollars, most central banks kept a large reserve of dollars.

Now take the Corona company in Mexico. It exported beer worldwide. Each importer in other countries traded with dollars. So the Corona company ended up with lots of dollar bills. But the Corona company could not pay its employees in dollars. It could not buy grain for fermenting from local Mexican farmers in dollars. It needed pesos. Thus, the company exchanged the dollars for pesos with the central bank of Mexico. The same held true for the Mexican company exporting bagged tortillas. Thus, international trade occurred in dollars and domestic trade in pesos. Dollars were used between countries, and local currency within countries. In 2015, this was the model.

What is the American central bank? I don’t recall hearing about it. The Federal Reserve. It has twelve branches in major US cities, such as Cleveland.

What does any of this have to do with China? Take one last example.

The importer of oil in Britain. That importer first had to exchange pounds for dollars, as oil was only sold in dollars. The local bank would make a profit on that exchange, so there was a cost to the importer. The importer then traded dollars with Saudi Arabia for oil. The British importer had to recover the expense of the currency exchange to maintain its profit margin. So in 2015 a Brit at the gas pump filling her car in London paid more than an American at a pump in Baltimore. Why? The importer of oil in the US did not need to make a currency exchange before trading dollars for oil with Saudi Arabia. Thus, the American got cheaper imported goods.

That discount could be measured. Suppose a typical fee to convert a currency into US dollars was three percent. Americans imported 2.7 trillion dollars’ worth of goods and services in 2013.[19] If Americans imported that same amount each year for the next century and saved three percent, they would’ve saved eight trillion dollars.

Would you be willing to get stiffed 4 trillion to make 8 trillion? You still come ahead 4 trillion. This was one benefit to Americans having their currency as the international currency. China was motivated to have the yuan as the international currency, so that its population enjoyed cheap imports. Losing four trillion was worth it.

Here, it got better. If I borrowed a million dollars, I could start a business, sell it, and repay the loan. I could make a profit. I used money to make money. Similarly, if I was Congress, I could borrow and pay federal expenses rather than raise taxes to do it. US corporations, avoiding the taxes, had more money to grow and had more wealth to distribute to stockholders (Joe and Jane American). Individuals, avoiding the taxes, had more disposable money to invest and got richer. So low interest loans to Congress translated into wealth for the US population.

Since central banks worldwide needed dollars and wanted to hold US notes rather than cash, Congress got low interest loans. If all this is true, the money changing hands in the US should’ve increased, because taxes were low. GDP is a measure of the sum total of all the money changing hands inside America and with American exporters within one year. In the 65 years before 2015, when the dollar was the international currency and Congress was borrowing, GDP for the US increased from 223 billion in 1945 to 14 trillion in 2010.[20] GDP increased by 62 times as much, although the US population had only increased by twice as much.[21] Yep, Americans had gotten richer. During the course of a half century, median income for Americans had increased 58 percent.[22]

For China it was worth losing four trillion for its population to acquire that wealth. (Of course, China didn’t actually lose four trillion but rather a much lower figure. After the US default, China was able to sell many of its US Treasury notes on the open market for a reduced value. Also, the US was forced to repay the notes China retained, as you will see shortly.)

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Thus, in 2025 the yuan gained the throne, ousting the dollar. The yuan was now the main reserve currency held by central banks across the globe. After the default, most nations lost confidence in the dollar. Moreover, most nations bought consumer goods from China. As said, China declared that all its exports must be purchased in yuan. Central banks worldwide now needed a large reserve of yuan not dollars.

And for most countries, their dependency on oil dropped immensely with hybrid cars, which were now the primary vehicle type. Historically, imported oil for a country was almost exclusively for the cars driven by its population. Since hybrids used half the gasoline, nations only needed to import half the amount. That lower oil need could’ve been satisfied from non-OPEC countries, such as Russia, Canada and Mexico. So the previous need to hold dollars to buy oil from Saudi Arabia and OPEC virtually disappeared.

Indeed, OPEC, desperate to sell its oil, now accepted yuan. In 2007, Iran had tried to persuade the other OPEC nations at a summit to quit selling oil in dollars. Although unsuccessful, Iran went ahead the next year and began selling its oil to Asia in euros and yen.[23] Venezuelan Presidents have had an anti-American attitude since the early 2000s starting with Hugo Chavez. So both member nations were happy to switch. China then offered OPEC military support.

Wait! Wouldn’t China lose the US market for its exports if it bankrupted America?

China had opened other markets, so the loss wasn’t too punishing. It was selling consumer goods to nearly the whole planet.

But how did China continue growing from 2015 to 2025? After all, they had ecological ruin, an aging population, and extreme poverty in rural areas as of 2015. Yes they did. So did the US in the 1930s. In Pittsburgh the air was dark at all hours of the day from industrial pollution. Lampposts burned brightly along downtown streets at ten in the morning. And dust storms swept across the prairies. They occurred partly from failure to apply dryland farming methods (ecological ruin). Tens of thousands of families had to abandon their farms in mainly Oklahoma. They were reduced to severe poverty (rural poverty).[24] Social security was started for the elderly (aging population). Despite the US having these same problems, the dollar took the throne and became the international currency ten years later in 1945. Likewise, China’s problems in 2015 didn’t inhibit the same ascendency a decade later in 2025.

The Chinese government had outsmarted Joe American. That was not hard, as Joe concerned himself little with political and economic matters outside US borders. The NFL, Oprah, and the lives of Hollywood celebrities were far more interesting. US politicians saw the writing on the wall, but could do little about it. Jim Cane would not have been elected to the US Senate, if he had promised to go to Washington and raise taxes, cut your social security, and eliminate Medicare. He had to arrive in Washington and get you more, to get reelected. When every Congressperson entered the Capitol Building with this mentality, they spent more. They had to, even knowing they shouldn’t.

During the Cold War with the Soviet Union, Joe American had a continual fear that the US was losing. It made Americans very productive. ‘We must work harder,’ thought Joe with deep anxiety. During the Currency War with China, Joe was complacent. He didn’t know there was a war. There were battle cries, but he didn’t bother to understand them. Joe was not productive, whereas Chen Zhang was. In 2012, a third of the US population was receiving a handout from the government, when we don’t count social security checks to retirees. When we count retirees, half the population was receiving one.[25]

Causing a US default to gain the international currency throne was a brilliant Machiavellian play on the chessboard of geopolitics.

In the early 21st century, Uncle Sam smoked a cigar on a summer afternoon from his rocking chair. His legs were outstretched on the porch railing of his rural mansion, as he watched the Mississippi River gently drift by. He was nearly slumbering. A droplet from the chilled pitcher of lemonade rolled onto the chessboard. Little did he know that three other chess players had just shown up on his front lawn. Carrying baseball bats. Since 1945, Americans have enjoyed being the center of the planet with a bustling economy. But in 1979, China opened up its borders, and in 1989, Russia did the same (when the Soviet Union collapsed). Both countries are massive landmasses with huge populations, rivalling the US. Another is India. These three new players each want to be the new United States.

China became the world’s new workshop. India became the world’s new services hub. With the US losing significant manufacturing and services to these nations, Americans kept shopping but with a lesser ability to earn. Borrowing to make up for the loss had its limit. The fun ended.

What did the US look like post-default? Let me put it this way—not beautiful.

 

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[1] https://en.wikipedia.org/wiki/Charles_de_Gaulle#U.S._dollar_crisis

[2] https://en.wikipedia.org/wiki/Petrocurrency#Currencies_used_to_ trade_oil

[3] http://www.reuters.com/article/us-saudi-usa-idUSBRE99L0K120131022

[4] https://en.wikipedia.org/wiki/Yuan

[5] https://www.creditwritedowns.com/2009/03/china-wants-to-get-rid-of-the-dollar.html; see also http://www.bis.org/review/r090402c.pdf (the essay).

[6] http://money.cnn.com/2013/10/10/news/economy/ecb-china-currency/

[7] http://america.aljazeera.com/articles/2014/5/20/russia-china-bankdeal.html; see also http://www.bbc.com/news/business-27503017

[8] http://www.aljazeera.com/news/2015/12/imf-approves-china-yuan-reserve-currency-151201035146246.html

[9] http://www.imf.org/external/np/sec/pr/2015/pr15540.htm

[10] http://www.usatoday.com/story/money/markets/2014/11/09/ cheat-sheet-china-gold/18644197/

[11] http://moneyweek.com/how-much-gold-china-owns/

[12] http://popularmilitary.com/china-special-military-unit-sole-purpose-acquiring-gold-country/

[13] https://en.wikipedia.org/wiki/List_of_countries_by_exports

[14] http://www.bls.gov/cew/ew07fig19.pdf

[15] https://www.cbo.gov/publication/49973, 2015-25 BudgetDataProjections.xlsx, Table 1

[16] https://www.rt.com/business/russia-london-club-debt/; see also http://www.countriesquest.com/europe/russia/economy/foreign_economic_relations_trade_and_investment.htm

[17] https://www.essex.ac.uk/e…/AU09/Jianan_Li_EC245.pdf, pp. 4 and 32.

[18] The debt rose by 8 trillion from 2015-2025. China lent three, and Japan lent two. Other countries combined lent three.

[19] http://data.worldbank.org/indicator/NE.IMP.GNFS.CD

[20] https://www.bea.gov/scb/pdf/2012/08%20August/0812%20gdp-other%20nipa_series.pdf, pp.183-4

[21] https://www.census.gov/population/estimates/nation/ popclockest.txt; https://www.census.gov/prod/cen2010/ briefs/c2010br-01.pdf

[22] http://www.census.gov/prod/3/98pubs/p60-203.pdf, p.7

[23] http://www.cbsnews.com/news/iran-ends-oil-transactions-in-us-dollars/; see also http://www.reuters.com/article/us-oil-iran-exclusive-idUSKCN0VE21S

[24] https://en.wikipedia.org/wiki/Dust_Bowl

[25] http://www.census.gov/programs-surveys/sipp/publications/ tables/hsehld-char.html#backtotop, Table 2