Could a Rip-Your-Face-Off Rally in the Dollar Trigger a Global Financial Crisis?
*Is this scenario guaranteed? No, of course not. But that doesn’t mean it’s excluded from the realm of possibility. *
We all know the end-game when currencies are inflated as an expedient measure to stave off insolvency: devaluation eventually has consequences as the debauched currency is eventually replaced, a process that wipes out everyone holding or using the devalued currency.
It’s natural to assume this is a linear process and therefore predictable, as that’s what it looks like when looking back at the broad sweep of history. But the process isn’t inherently linear; it’s non-linear as the dyn…
Could a Rip-Your-Face-Off Rally in the Dollar Trigger a Global Financial Crisis?
*Is this scenario guaranteed? No, of course not. But that doesn’t mean it’s excluded from the realm of possibility. *
We all know the end-game when currencies are inflated as an expedient measure to stave off insolvency: devaluation eventually has consequences as the debauched currency is eventually replaced, a process that wipes out everyone holding or using the devalued currency.
It’s natural to assume this is a linear process and therefore predictable, as that’s what it looks like when looking back at the broad sweep of history. But the process isn’t inherently linear; it’s non-linear as the dynamics around “money” and “risk” are emergent, meaning that the sum of the parts have qualities of their own that are not predictable.
Which brings us to the question: could the much-maligned, guaranteed-it’s-going-to-zero US dollar USD) stage a rip-your-face-off rally that wipes out those shorting the USD by generating a mad rush for scarce–yes, scarce–USD?
The Federal Reserve measures the supply of US dollars via M2: basically cash in various accounts. As you can see on the chart below, M2 Money Supply is about $22 trillion after a $6 trillion rocket-boost in the Covid stimulus phase.
That may sound like a lot, but consider the global bucket of financial assets is worth $480 trillion. Global Asset Monitor: Public (sovereign bonds, etc.) $232.4 trillion, Private (stocks, RE) $246.8 trillion: $479.2 trillion total.
So M2 Money Supply is 4.6% of global financial assets. US dollars in circulation, i.e. Federal Reserve notes/Greenbacks, is around $2.4 trillion.
The US dollars held in time deposit accounts in banks outside the US are called Eurodollars. I am not an expert on the eurodollar market, but it appears to have experienced a decline in volume since 2016. As this article from the Federal Reserve Bank of New York explains, changes in banking regulations led to selected deposits on the books of US banks replacing the majority of eurodollars volume.
Who Is Borrowing and Lending in the Eurodollar and Selected Deposit Markets?
- “Selected deposits are unsecured U.S. dollar deposits that also tend to have an overnight maturity, similar to Eurodollars. However, unlike Eurodollars, but like fed funds, selected deposits are booked at bank offices in the U.S.”*
The conventional view is that eurodollars are advantageous because they are not regulated by US agencies or the Federal Reserve and so much of the activity is opaque, qualifying as “shadow banking.” Eurodollar Secrets: The Hidden Engine of Global Finance (tradingview.com)
*“The Eurodollar system is one of the greatest financial innovations–and enigmas–of modern capitalism. Born from geopolitical necessity, it evolved into a vast offshore network that creates and circulates U.S. dollars beyond U.S. borders.
Its power lies in its invisibility: it influences global liquidity, shapes monetary policy, and fuels international trade, all without direct oversight.
However, with great power comes great risk. The Eurodollar market’s opacity and lack of regulation mean it can amplify crises when liquidity dries up.“
As I understand it, a non-US bank holding $100 million in eurodollar deposits can issue loans denominated in USD based on the USD on deposit. In this case, the quantity of USD is increased not only by the Federal Reserve or US banks but by non-banks holding eurodollars.
There were an estimated $13.8 trillion eurodollars in 2016. I haven’t found any more recent estimates that aren’t paywalled. Back of the envelope, let’s say there are around $17-$20 trillion in eurodollars floating around, which would put total USD in the global financial system around 8% ($38 trillion) or 9% ($43 trillion).
Here is the chart of M2 Money Supply, courtesy of the Federal Reserve:
Why would anyone need USD? The usual reason is to service or pay off USD-denominated debt. As credit tightens–which happens when global markets shift from risk-on to risk-off–loans denominated in USD issued by non-US banks (i.e. eurodollar credit) mature and the lender demands payment in full rather than roll the debt into a new loan.
The borrower must then buy dollars to pay off the loan. Just because there are a lot of dollars in existence doesn’t mean there are an abundance of dollars available. When a loan denominated in dollars is paid off, those USD that were borrowed into existence go to Money Heaven.
So the total supply of dollars can shrink in a risk-off crisis as loans are called and liquidated. Much of the supply of USD is tied up and not available for borrowing. In risk-off crises, dollars are hoarded, reducing the supply available for lending.
Given the enormous size of the global financial assets bucket–and the unknown but estimated to be gigantic market of USD-linked derivatives such as currency swaps–the demand for dollars could far exceed the amount available to desperate borrowers and those at the end of derivative chains that eventually lead back to some form of USD-denominated collateral.
This is one scenario for a rip-your-face-off rally in the US dollar that wipes out dollar shorts (those betting on a decline in the relative value of the USD against other currencies), bankrupts borrowers who were unable to secure enough dollars, and forces eurodollar lenders into insolvency when the USD-denominated loans they issued are not paid back.
In systems terms, a risk-off global crisis is a self-organizing criticality that can trigger a phase change much like an avalanche–a dynamic I describe in my new book Investing In Revolution:
*“These dynamics of complex systems are illustrated in the Sand Pile analogy: as grains of sand drop out of a hopper, they form a pile which grows in size until it reaches a point of instability, and the sand pile collapses in an avalanche. Which grain of sand will trigger the instability cannot be predicted, and neither can the size of the avalanche.
The sand pile is an example of self-organized criticality, a self-organizing system that hovers between instability and stability. At a critical point/tipping point, a phase transition occurs–the avalanche. Avalanches / instabilities follow a power law distribution: for every 100 small avalanches, there will be 10 that are considerably larger, and one gigantic one that takes down the entire system.“
And that’s how a rip-your-face-off rally in the guaranteed-it’s-going-to-zero US dollar triggers an avalanche that topples multiple lines of dominoes stretching throughout the global financial system. All sorts of collateral would be liquidated to raise funds to buy dollars, and that’s how the world ends up with a global financial crisis few thought possible.
Is this scenario guaranteed? No, of course not. But that doesn’t mean it’s excluded from the realm of possibility.
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