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Risk Concern report (Currencies)
© RISK CONCERN. All Rights Reserved. All material included in the report is included with full permission.
Summary:
1. The US GNP, GDP, and USD denominated assets available for exchange hold the governing power over the absolute worth of the USD. 2. A currency's exchange rate in relation to another currency should not be of primary concern when gauging the absolute worth of a currency. 3. Explanation of what exactly is backing the USD is provided. 4. The nominal amount backing the USD, stands at $1079.3 trillion, and a real amount, in 1970 Dollars, stands at $208.4 trillion; this amount, aligned with the Gold standard peg of 1970, translates 5.95 trillion ounces of Gold.
Further Suggested Reading (Free): Shafqat, Shahrukh, Intrinsic Value of the Dollar: An Evaluation, and Scrutiny of the Absolute Worth of The U.S. Dollar. (December 3, 2020). Available at SSRN: https://ssrn.com/abstract=3741880 or http://dx.doi.org/10.2139/ssrn.3741880
© RISK CONCERN. All Rights Reserved.
With over 40% of dollars printed recently, with further expectations of 'helicopter payments' and a certainty of quantitative easing if systemic risk perceptions increase, the concerns regarding the worth of the USD are very logical.
As the FED does not hold an equally offsetting asset on its balance sheet, equivalent to its currency liability at a specified rate, as it did under the gold-standard, it may be argued that the USD may be printed to infinity; also, it may be asked . . . What's theoretically stopping them? 'The experimentation' of quantitative easing, which some argued would sow the seeds of secular inflation, has not materialized. This, arguably, may have influenced perceptions regarding what can be done in monetary policy, 'safely.' This may lead to 'monetary gymnastics' if needed.
Critics bringing up inflation concerns, for example, maybe muzzled by the longitudinal 'data' since 2008; using the past data, the FED may state that inflation concerns are not of paramount importance. The FED may state that the flexibility of the money supply, and the FED's maneuvering of it, to follow its congressional mandate, to 'promote the goal of maximum employment' effectively are a necessity. This may, in time, severely impact the purchasing power of USD negatively.
The worth of the USD impacts a significant percentage of the global population, and fundamental signaling parameters, beyond the commonly used indices, are needed to understand and forecast the value of the dollar – not its exchange rate in relation to other currencies, but its absolute worth, the intrinsic value of the USD. So, from what element of intrinsic value does the USD derive its worth now?
Shafqat (2020) states:
The critical viewpoint, primarily, states that the Federal Reserve does not hold an asset position, of units of intrinsic value, that would equipoise, at a predetermined rate, its currency liability; thus, presently, there is nothing of intrinsic worth, such as Gold, to be backing that liability. Therefore, the Dollar, it is claimed, does not derive its worth from any element of intrinsic value, and thus, has no intrinsic worth. (p.2)
And a connecting question that arises is that: if there is nothing of intrinsic value backing the USD now, isn't it, arguably, worthless?' 'What is the dollar deriving its value from?'
Shafqat (2020) states:
It may be accepted that a populous may recognise a currency as a legal tender due to the prescription of the law, and, thus, be required by the law to use it as the medium of exchange; this may explain national acceptance, and demand of a currency in a region; however, in the case in question, as international economic participants are free of any legal obligations internal to the U.S., the question that arises is that why is the USD in demand internationally? If we accept the critics' viewpoint that the USD has no intrinsic worth, why then are two-thirds of the Dollars held abroad (USDT, 2003; FED, 1996)? Why are international economic participants not attracted more towards units of intrinsic value, and why do they not shun the USD as intrinsically worthless?
The simplistic answers, alluding to the stability of the Dollar and its instrumental role in the global economic system, do not answer the heart of the matter. The questions: what is the intrinsic value of the Dollar? Is it quantifiable? Remain unanswered; instead, circumstantial realities are pointed out, such as the Dollars' stability and its role in the global financial system. The questions: What is the Dollars' absolute quantifiable worth? Moreover, how does the Dollar derive its value? Are not answered by these circumstantial facts; it is, therefore, deflective reasoning. (p. 2-3)
What is it, then? What is the fundamental backing of the USD? Surely, even a government cannot magically convert paper with illustrations printed on it, and coerce people into accepting it as valuable; not just that, but also influence international participants to assume it as being valuable.
Shafqat (2020) answers the question as follows:
The Dollar derives its worth from a mechanism, which itself is supported by the inflows that the principal USD issuing entity, the U.S. government receives, as well as the international and national USD-denominated value generated, and net assets available. (p. 26)
What does this mean, simplistically?
The key elements holding a governing power over the absolute worth of USD are the US GNP, GDP, and net assets available for exchange, and the position of the USD as a currency of choice for international trade (which, of course, is governed by the stability of the USD, its prominence and acceptance). The present value of these elements, i.e., the discounted worth of these elements that also considers growth, supports the intrinsic worth of the USD.
Shafqat (2020) states:
In the current international forex system, a currency index, and thus a currency, appreciates, when 'a weighted geometric average bilateral exchange rate' moves in its favour; for example, the Dollar-index appreciates when the weighted geometric average bilateral exchange rate, moves in Dollars' favour. The reason, of course, is the demand of the USD, in relation to weighted trading partners of the Dollar, increases. The reason for this demand increase is that more international economic participants want to exchange their currencies for the USD; this increase, fundamentally, is caused due to increased demand in the Dollar-denominated productivity, i.e., U.S. Dollar-denominated goods and services, etcetera.
Here, it may be argued, that the demand for USD also increases due to countries acquiring foreign exchange reserves to keep their local currency fluctuations in a bounded range, or for crisis management, etcetera; however, the foreign exchange reserves are also an exchange of value; it is the worth of the USD that is considered to be a counterweighing force in a crisis, or counterbalancing force in the foreign exchange interventions. The USD is also the most prominent currency in the international balance of payments. The core value of the USD, nonetheless, is not derived from this international demand – this international demand is because of the core value; the demand is not the core value itself.
The weighted geometric average bilateral exchange rate appreciates in the favour of USD, and the USD commands an international demand because of the Dollars' core worth, or units of value backing the Dollar, due to being USD dependent, which seen through an alternative prism, can be used to evaluate the units of intrinsic value backing the USD. An alternative lens of understanding must be applied to decipher these 'units of intrinsic worth,' and to quantify the Dollars' intrinsic value holistically, now, in a world far beyond the days of the Gold standard.
An analogy that sets and clarifies the basis of the argument presented in this paper is elaborated below:
Let us assume there is a country, country X, with a population of ten people. The people trade amongst themselves, using Cowrie shells (Monetaria Moneta). Each person in country X produces ten units of productivity, not identical, but equal in worth; thus, annual productivity is
100 units. Let us assume that there are 100 cowrie shells in circulation (total money supply is 100 cowrie shells). What would then be the cowrie shells' intrinsic worth? It may be argued that the worth of the cowrie shells is perceptual, and a psychological phenomenon based on scarcity, and this would, partly, be a valid point; however, when we ask the question regarding the value backing the cowrie shells, the scarcity of the shells themselves is not the fundamental element to be considered. We are confronted with the value limitation, the 100 units of productivity in country X; as the total productivity is 100 units, and there are 100 cowrie shells (the money supply), the total units of productivity, and thus, the intrinsic value, are the 100 units of productivity. This productivity limit is a 'value limitation' on the cowrie shells as well. This means that no more units of absolute worth may be acquired in that period, no matter how many cowrie shells are acquired by an economic participant.
For example, if 100 more cowrie shells are found by people, and searching divers, with the total cowrie shells now amounting to 200, what would be the value backing the cowrie shells? Seen through an alternative prism of understanding, as the productivity limitation for the period is 100 units, the total value backing the cowrie shells is 100 units; therefore, 0.5 unit per cowrie shell. There are no more units of absolute worth, or intrinsic value, obtainable, and this value limitation is also a limiting factor on the worth of the cowrie shells; the cowrie shells, thus, do not possess infinite value. (p. 7-8)
The fundamental elements in a value equation for a medium of exchange are the productivity and net assets available for exchange; these elements are a fundamental reality holding a governing power over other elements, such as currency value, inflation, and deflation. (p. 10)
All entities that operate with the USD being their functional currency, generate value in the USD; i.e., the intrinsic value their operations create, their productivity, is converted into Dollars, because of the USD being their principal medium of exchange; thus, this value generated is part of the holistic mechanism backing the absolute worth of the USD. U.S. citizens, and citizens of Dollarized economies working abroad, arguably, consider the USD as their primary currency (p. 11)
Inside the U.S., the Dollar is a carefully orchestrated 'connective tissue' that efficiently distributes the units of productivity and net assets, proportionate to the relative units of productivity, or relative net assets, held primarily. Outside the U.S., the Dollars' worth is supported by the dependence of a significant proportion of the international productivity being reliant on the USD, for the time being. It would provide a 'snapshot' view for a period, but unlike the Gold analogy used above, the total amount of Dollars are not used and extinguished every period; there are savings, investments, and unsettled units of absolute worth produced in previous periods that must be taken into account.
Furthermore, the intrinsic value lies not just in the productivity and net assets dependent on the USD, or a value limitation at the very maximum; it lies in the mechanism playing a critical role in the efficient functioning of the units of value. Put simply, the units of absolute worth, i.e., the productivity and net assets, are the rudimentary value, but there is a holistic value in the mechanism that generates the value backing the USD, and a calculation of that, i.e., the valuation of the mechanism holistically, which would include the wide-ranging analysis of all available net assets and productivity of previous periods, etcetera. This exercise 'should comprehensively, deciphers' the intrinsic value of the Dollar – its absolute worth. (p. 10-11)
This primarily means that the dollar's future value is going to be determined by the number of currency units in circulation to US GNP, GDP, and assets available for exchange ratio. If the units of currency in circulation (money supply) increase, but the GNP, GDP, and assets available for exchange decrease, the value you can acquire by every 1 dollar is reduced, and the absolute worth of the dollar decreases. However, if the units of currency in circulation (money supply) is decreased, or remains stable, and GDP, GNP and assets available for exchange increase, the absolute worth of the USD would increase.
The exchange rate in relation to another currency should not be of primary interest to savers or asset managers, for example. This is because if the other currency is 'printed' at the same rate as the dollar, and the real rate of interest between the two currencies remains the same, as per the covered interest parity theory, no real exchange difference would occur. However, the absolute worth of the two currencies can be drastically different if the GDP, GNP, and net assets available in a specific currency increase in relation to the available units of currency (money supply).
Shafqat (2020) states:
If the money supply is not managed prudently, in quantity proportionate to the increase in productivity, the Dollar, theoretically, would not be able to hold its overall exchange value, as the value in the mechanism backing the Dollar would not be representing the same broader amount of currency in circulation. Presently, this danger is real, as there are many threats to the value of the Dollar, with the most prominent ones being internal, for example, the implementation of inviable policies by imprudent politicians or demagogues. The most critical risk trigger to follow would be any signalling by the Federal Reserve to 'accommodate' economically inviable political demands. (p. 26-27)
Finally, the mechanism that Shafqat (2020) describes to calculate the value of the dollar, quantifies "the nominal amount backing the USD, $1079.3 trillion, and a real amount, in 1970 Dollars, of $208.4 trillion; this amount, aligned with the Gold standard peg of 1970, translates to 5.95 trillion ounces of Gold."
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