Rickards: The Dollar’s Not Dying
Last week, financial headlines were filled with doomsday warnings: “$40 trillion in national debt!” “U.S. debt trapped in a downward spiral!” “The dollar’s demise is imminent!”
Amidst this bleak outlook, gold and bitcoin surged alongside predictions of the dollar’s collapse. Taking these headlines literally, one might believe the dollar had already failed and that U.S. Treasuries were worthless.
However, the reality is that the dollar’s status as the primary global reserve currency remains secure. Foreign exchange reserves aren’t just stacks of cash; they mostly consist of liquid financial instruments, prominently including U.S. Treasury securities denominated in dollars.
Assets priced in dollars will continue to dominate international reserves well into the future.
The reason is straightforward: very few sovereign bond markets match the U.S. Treasury’s vast size, liquidity, and depth. Government debt markets in countries like Japan and major European nations lack this unique combination. Thus, the dollar will retain its supremacy.
This doesn’t imply that interest rates won’t climb or that inflation won’t rise—both are quite possible. Yet, these trends do not signal the dollar’s collapse. Rather, they mean that the Treasury will pay more to borrow, and consumers might face higher costs at the pump and supermarket.
While the dollar bond markets face challenges, panic over currency debasement is an unproductive lens through which to analyze them.
BESSENT GOES AFTER THE BOND MARKET
U.S. Treasury Secretary Scott Bessent recently unveiled a strategy to tackle rising interest rates on U.S. Treasury securities, which also impacts mortgage and credit card rates. The plan includes both immediate and long-range measures.
One short-term step involves the U.S. backing Japan’s attempts to stabilize the yen through joint currency intervention and possibly expanding the Federal Reserve’s FIMA Repo Facility. This tool lets Japan borrow dollars using its U.S. Treasury holdings as collateral instead of selling those securities outright.
This approach could alleviate some upward pressure on U.S. interest rates. Japan currently holds approximately $1.12 trillion in U.S. Treasuries as of June, making it the largest foreign owner.
Another immediate tactic is for the Treasury to buy long-term securities, particularly in the 10- to 30-year range. Recently, the Treasury announced plans to at least double specific buyback operations from $2 billion to $4 billion, with potential for further expansion.
Moreover, the Treasury has heavily utilized short-term maturities like one-, three-, and six-month Treasury bills in its financing mix. These shorter instruments typically carry lower interest costs than longer-term notes and bonds. Increasing reliance on short-term bills can reduce borrowing expenses in the near term.
Treasury bills are favored by dealers and hedge funds due to their high liquidity and extensive use as collateral in financial trades. Supporting liquidity at longer maturities while maintaining substantial short-term Treasury supply is logically sound. The media frenzy over this strategy remains puzzling.
BESSENT’S 3-3-3 GAMBIT
The long-term portion of Bessent’s plan is often called the Three Arrows.
The first arrow aims to keep annual deficits at 3.0% or less of GDP. The second targets achieving GDP growth of 3.0% or more. The third focuses on raising U.S. energy output by the equivalent of 3 million barrels of oil per day.
Hence the shorthand 3-3-3: a 3% deficit, 3% real GDP growth, and 3 million extra barrels of oil equivalent daily.
While oil production isn’t a direct fiscal policy factor and can be set aside for this discussion, the deficit and GDP growth targets are crucial.
The key figure investors watch regarding confidence in U.S. Treasury securities is the debt-to-GDP ratio. It’s misguided to panic over a $40 trillion national debt without relating it to the GDP available to service and refinance that debt.
Currently, gross federal debt stands at about 123% of GDP—$40 trillion of debt divided by approximately $32.5 trillion of nominal annualized GDP—a ratio near historic highs.
Elevated debt-to-GDP ratios can hinder growth and limit governmental flexibility during crises. A 60% ratio is more manageable, with even lower ratios like 30% being preferable. The previous peak was near the end of World War II.
Zeroing out the annual deficit is unrealistic. Likewise, reducing the national debt anytime soon is unlikely.
Neither of these facts is consequential.
The crucial factor is whether the debt-to-GDP ratio declines.
This occurs when the economy expands faster than the debt. If that happens, the ratio falls even with rising debt. That underpins Bessent’s strategy, exemplified when he claimed the U.S. could “grow its way out” of its debt challenges. Theoretically, he’s correct.
Consider a $2 trillion annual deficit increasing national debt to $42 trillion (a 5.0% rise). If GDP grows from $32.5 trillion to $34.5 trillion (a 6.2% increase), the debt-to-GDP ratio slips from about 123% to 121.7%. Still very high, but lower than before.
That’s precisely the signal bond market vigilantes seek. As long as the debt-to-GDP ratio declines, bond investors retain faith in U.S. Treasuries and the dollar.
Historically, the U.S. achieved this: federal debt-to-GDP fell from roughly 119% in 1946 to near 31% by 1980 over three-plus decades, across administrations, by using fiscal and monetary policy, sustained nominal growth, and inflation.
During that span, debt rose markedly. Yet GDP grew by over 1,000%. This dynamic was the critical factor. When GDP outpaces debt growth, the ratio falls, improving the country’s fiscal health.
HERE’S THE DIRTY LITTLE SECRET
That being said, there is a less-discussed truth in Bessent’s plan.
Government debt-to-GDP calculations use nominal figures, not inflation-adjusted values.
In the previous example, GDP rose 6.2% while debt climbed 5.0%, lowering the ratio. But this doesn’t distinguish how much GDP growth was genuine versus inflation-driven.
The 6.2% nominal growth might reflect 4.2% real growth and 2.0% inflation, a reasonably healthy mixture—or alternatively 2.2% real growth with 4.0% inflation.
At 4.0% annual inflation, the dollar’s purchasing power halves in about 18 years, then halves again over the next 18. Such inflation can devastate your savings and income if unprepared.
So, how much inflation underpins the Bessent Plan? Secretary Bessent has not specified.
Investors should prepare for the worst-case scenario.
Since the global financial crisis, real U.S. growth has struggled to exceed roughly 2.0% annually on average. If roughly 6.0% nominal growth is needed to outpace debt growth and real gains hold around 2.0%, the remainder must stem from inflation.
This suggests about 4.0% inflation.
This isn’t a preference but simple arithmetic.
When recounting how the U.S. dramatically reduced its debt-to-GDP ratio from World War II’s end until 1980, it’s important to recall that consumer prices surged about 50% between 1977 and 1981.
This was one way the government managed to address the debt challenge.
Having lived through that era, it was beneficial if you owned gold or real estate, used leverage, or held a job with frequent raises.
Conversely, it was difficult if you relied on fixed-income sources like annuities, pensions, insurance plans, or Social Security.
Which side of that scenario applies to you?
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