Power Up Wealth podcast – Global Reserve Currency Part 1 – Episode 49 transcript:
James Derrick 0:00
The US dollar dominates global trade and brings Americans all kinds of benefits. When will we lose this financial advantage? I am James Derrick, Chief Investment Strategist at Smedley Financial Services. Today my guest will be Jordan Hadfield. He’s going to help us understand what it means to have the US dollar as the world currency, how we got here, and answer the question, is it at risk?
Sharla Jessop 0:37
Welcome to the SFS Power Up Wealth podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
James Derrick 1:00
This is part one in a series on the US dollar as a reserve currency. Jordan, thank you for being here today.
Jordan Hadfield 1:07
I’m very excited to be here.
James Derrick 1:08
Jordan Hadfield is a wealth consultant and financial advisor at Smedley Financial Services. He has a CFP designation, a university degree in financial planning, and is an entrepreneur. And we’re so glad to have you. This is a very complicated topic. We’re going to start out with the basics. What is a reserve currency? Why does it matter?
Jordan Hadfield 1:28
It is complicated. I want to simplify it as much as possible, while still providing some information that is useful and enlightening on the subject of the world currency, the US dollar’s status is the reserve currency, how we got here and where we’re going. So I look forward to the conversation. We do need to start with the basics. What is a reserve currency? And why do we have a reserve currency? A reserve currency is a single currency used throughout the world and global trade? It’s a currency that most if not all countries in the world agree to exchange. The way I can illustrate this point is using candy. If I have a Snickers bar, and I want a KitKat. I need to trade with someone who has a KitKat. But what if the person who owns the KitKat doesn’t want a Snickers. Let’s pretend the person that wants a KitKat and will only accept a Reese’s Peanut Butter Cup. So now I need to find someone who holds a Reese’s Peanut Butter Cup. James, let’s say you hold the Reese’s. Just so happens that you want my Snickers. I’m going to trade my Snickers bar for a Reese’s with you. And then I can trade my Reese’s for the KitKat that I want. That is the purpose of a reserve currency. It’s a currency that is sought after in the world. Other countries will trade their currencies for the reserve currency to make international change easier. There’s also something called exchange rate risk. Again, I don’t want to make this too complicated. But one of the biggest benefits of having a reserve currency in the world is to minimize exchange rate risk. The value of currencies fluctuate. So let’s pretend that the KitKat dealer and I agree on a price. And so I ship my money to him in exchange for a KitKat. But by the time that the transaction is agreed upon, to when I receive my KitKat, the value of my money has changed relative to what it was initially. Now, I could end up paying more for the KitKat than I agreed upon, or the receiving company, right in another country, could be receiving less money than they agreed upon for their KitKat. This is exchange rate risk, the value of currencies are fluctuating throughout time. So in order to minimize that, and to facilitate global trade with less exchange rate risk, a reserve currency comes into play. Currently that reserve currency is the US dollar.
James Derrick 3:51
Sounds like we’re gonna need a lot of Reese’s Peanut Butter Cups.
Jordan Hadfield 3:53
I hope so.
James Derrick 3:54
If the whole world wants to start trading for them. This makes me think that a reserve currency is almost essential, regardless of which currency it is. I know we’re going maybe off topic here a little bit down a rabbit hole. But when you look back in history, have we always had reserve currencies?
Jordan Hadfield 4:12
I can tell you there has been six reserve currencies since 1450.
James Derrick 4:17
Wow.
Jordan Hadfield 4:18
So before then, I’m not sure what the world was like that far back. But there has always been a supply and demand issue when global trade has been present. And so in some form or fashion. Yeah, I would think there has been a reserve currency. It probably doesn’t look like it does today. But at some form or fashion. There was demand for some currencies and not demand for others. And that created problems that needed to be fixed. Those problems are solved by a reserve currency.
James Derrick 4:47
That’s fascinating. And maybe we’ll hit that in the next podcast a little bit more about the history. For those offering the Reese’s Peanut Butter Cups. What are the benefits? What are the benefits to the US dollar being a reserve currency?
Jordan Hadfield 4:59
Yeah, so there’s a number of benefits in having reserve currency status. Again, United States currently has reserve currency status. And we enjoy these benefits. Because the dollar is in such demand, the dollar is strong. And so it helps stimulate the economy, right? It minimizes economic risk in our country relative to economic risks in the world. It brings stability to our country. That’s a huge advantage. Another huge advantage is the fact that we can borrow money at a lower interest rate. Because the demand for the dollar is higher, right, it brings interest rates down. And again, I can illustrate this using candy bars. If I’ve got one candy bar, and there are three buyers, for this one candy bar, they’ll bid the price up, someone will bid 50 cents. And the next guy will say this is my only chance. If I want that candy bar, I’m going to bid 55 cents. And the third, I want 60 cents. And here we go off to the races. And it’ll drive that price up. But if I’ve got three candy bars, and there’s two buyers, there isn’t an necessity to drive the price up. An interest rate is just the price of money. And so if there’s more demand for the dollar, and there’s more dollars in the system, the price for that dollar won’t be driven up as high, you can borrow the dollar at a cheaper cost. You can buy the dollar at a cheaper cost keeping interest rates low. And the fact that the US government can borrow at a cheaper cost does a number of things. Number one, it allows them to maintain a higher deficit. They can borrow more money without risking the safety of the US economy. That’s a big one. But that also translates all the way down to the consumer. So it’s not just the government that can borrow cheaper, it’s also us as citizens of the country that can borrow cheaper. And as we borrow at a cheaper rate, we’ve got more money to pump back into the system. So it fuels economic growth.
James Derrick 7:02
Well, so we make money out of thin air, basically on a computer. And then we trade it for goods, real tangible items. That’s remarkable.
Jordan Hadfield 7:13
Yeah.
James Derrick 7:13
Now, if we do too much, then I guess the interest rates might move up on us.
Jordan Hadfield 7:19
And that’s exactly what we’re seeing currently. You know, with COVID, we pumped a lot of money into the system. You may say that we pumped too much money into the system. That’s what happened to inflation. It pushed inflation up. And in order to combat inflation, the government had to raise interest rates, right to bring inflation down. So this definitely gets complicated. You can’t tweak one area of the machine without it affecting multiple areas of the machine. But essentially is it comes back to a reserve currency. The status of holding reserve currency allows us to borrow money at a cheaper rate. It provides stability to the country, and it fuels economic growth that other countries these benefits other countries just don’t have.
James Derrick 8:00
Do we have any responsibility? If you thought that was deep and difficult. Do we I’m going to ask this question. Do we have any responsibility to the world regarding our currency?
Jordan Hadfield 8:10
Yes, we do. And this may surprise a lot of people. You know, I hear all the time that America needs to mind its own business, right? I hear people say that. And that’s a political pathway that I’m not going to walk down in a podcast like this. But there’s a lot of people that feel like, hey, America is America’s first, second, and third concern. When it comes to reserve currency status. That’s not absolutely true. Of course, America cares about America more than anyone else. But because we have world currency status, we also have a responsibility to other nations. Economic policy becomes an international issue, because we have reserve currency status. So yes, it is something that we need to consider. And the reason being is, if we only issue economic policy that benefits America, other countries will no longer want to hold the US dollar as the reserve currency. In other words, we have to answer to other countries to some degree, if we want them to continue being our allies. And if we cause too much economic harm for our own benefit throughout the world, these other countries will abandon the dollar eventually, and adopt a new currency. So yes.
James Derrick 9:31
That sounds a little frightening. But I imagined that it’s been that way since the very beginning. America has been working for its own self interest, mainly, since it became a world reserve currency. And none of that has really changed. So I imagine that we’ve been balancing these concerns for quite a while. Let’s jump to the downside.
Jordan Hadfield 9:50
Yeah, and I just want to add real quick, not just America, every reserve currency holder has had to deal with this. It’s called the Trefelin Dilemma. For anyone who holds a reserve currency status. This is an issue that they’ve got to work with.
James Derrick 10:03
Let’s talk about downside. What are the downsides to being a reserve currency? Obviously, we’ve established there’s a great demand for dollars in the world, and that the value is high. Higher than it would be, then if people were trading in some other currency.
Jordan Hadfield 10:20
Yes, because the demand for the dollar is higher. That means importing becomes cheaper, right? Because the dollar is held at a higher value because of the reserve currency status. We can purchase outside goods and services for cheaper than we can domestic goods and services, right. And so holding reserve currency status tends to increase imports. And it also decreases exports. One of the big problems that the issuing country of the reserve currency has is keeping this balance. We need to keep our own country strong, and our own economy strong without going into trade deficits, and yet also continue to implement economic policies that are beneficial to the world. And so what ends up happening is you’re the reserve currency holder. And this is inevitable, there’s really no way around it, you end up strengthening the countries outside of your own. Eventually, if things aren’t held in a very tight balance, you end up weakening your own country. So it’s a balance. Now, that doesn’t mean that holding reserve currency weakens the country of the reserve currency holder. America has been the economic powerhouse in the world for a long time. Right? We’ve held that balance. But if things ever got out of balance, what would we would be doing as the reserve currency holder is strengthening international countries and weakening our own, and therefore being the reserve currency issuer can lead to the demise of being the world currency issuer, right? If that makes sense.
James Derrick 12:02
Yeah, I’m following it. Reminds me of the expression having your cake and eating it, too.
Jordan Hadfield 12:08
Yeah.
James Derrick 12:08
So the benefits outweigh the costs. Do you agree with that?
Jordan Hadfield 12:12
Absolutely. Yes.
James Derrick 12:14
So you’re strengthening other countries as a result. China’s a good example, because they’re manufacturing a lot right now. And we’re buying a lot of things from them. And their country has been growing at a faster GDP than ours for quite some time. But our standard of living is also much higher.
Jordan Hadfield 12:31
Yeah, America. Yeah, America likes to consume. And so importing is good. That allows us to continue consuming at a rate that we couldn’t consume otherwise. If all of our goods were produced here in America, we could afford a lot less goods, because America is more expensive. And so importing goods from other countries allows us to consume. And that’s what we like to do is consume. So yes, there are benefits from importing, there are benefits from having the reserve currency status. And these benefits far outweigh the cons. But there are cons and we need to be careful of them.
James Derrick 13:04
So you’re talking here about the trade deficit. And as you mentioned, we import more than we export. It’s been that way I think my whole life.
Jordan Hadfield 13:12
Yeah, long time.
James Derrick 13:13
How far can we stretch that? Is there a limit to the trade deficit?
Jordan Hadfield 13:18
Yes, there is a limit. I don’t know what it is. Nobody knows what it is. That’s the key question, right there is how much of a trade deficit can we hold before we start to harm the country? Nobody knows. We have the trade, we’d like you say we have held trade deficits for many, many years for a very long time. We’ve held trade deficits. We haven’t seen the negative effects of those trade deficits. If we push that too far, we could harm the country. We don’t know what that limit is.
James Derrick 13:47
I imagine the way that we would see this occurring. Some evidence of this would be a weakening of the US dollar, which is not what we have been seeing lately. In fact 2022, in my mind is a year when the US dollar was incredibly strong. So it seems to me, although there’s a lot of talk about the weakening of the US dollar, it’s not actually taking place yet.
Jordan Hadfield 14:10
I do want to point out though, just to emphasize this, there are countries out there that have trade surpluses, and haven’t seen economic growth. They’ve been stagnant, despite the fact that they’ve got trade surpluses. And so just holding a deficit in and of itself isn’t dangerous. Holding too much of the deficit would be.
James Derrick 14:29
All right. Let’s finish up with some other benefits financially to the country as a whole. Jordan, why don’t you talk about the budget deficits and taxes and how this plays into maybe individuals pocketbooks?
Yeah. So we touched briefly on the fact that because America has world currency status, they can take on larger debt, and how that trickles down to the consumer. We are able to borrow money at a cheaper rate. Now that also affects taxes because government debt has got a lower interest rate, the government doesn’t need to raise as much money to cover those debts. And so it keeps taxes lower. And of course, being able to borrow money at a cheaper rate holding taxes at a lower rate means that the consumer, the worker, the American worker, keeps more money for himself and is able to spend more money in the marketplace to consume the products they want to consume or invest the way they want to invest and build wealth at a higher ability than they would otherwise. And so the deficits can be held in larger degrees without hurting the US economy without hurting the US consumer.
Fantastic. I really appreciate you coming in for this interview. In the next podcast with Jordan, we will be discussing the history of the US reserve currency, how we got here into our current state. I look forward to that with you Jordan.
Jordan Hadfield 15:57
Yeah, so I thank you so much.
Shane Thomas 15:58
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn. The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
