What will happen to the dollar?

It is one of the most frequently asked questions ⁽¹⁾. This article is written in order not to “wag” the tongue speaking the same to various people.

As it is known, the value of the dollar, as of any commodity, is defined by demand and supply.

How is the supply formed?

Things are quite clear with this issue and all procedures are registered in the U.S. legislation. If loan issue is necessary, then the Board of Directors of the Federal Reserve System sends a request to the Senate and, in the case of a positive outcome of oftentimes quite complicated debates, the senators allow issuing a certain amount of dollars.

As of January 1, 2009, the money supply of U.S. dollars on the monetary aggregate M1 amounted to $ 1.6 trillion, and on the monetary aggregate M2 - $ 8.1 trillion.

And how is the demand formed?

The demand for dollar is formed both inside and outside the USA.

The U.S. home market need for dollars is conditioned by:

the necessity to pay taxes;
settlements with the government when buying state-owned property; and
the necessity to satisfy debts or perform any payments in the territory of the given country.

Let us consider these sources of demand for dollars separately.

The necessity to pay taxes.

Since any decent government accepts only its own national currency as a means to pay taxes, and in the USA one can pay taxes only with U.S. dollars ⁽²⁾, the demand for dollars for this purpose (as for any other national currency) depends upon:

the ability of the government to collect taxes;
the ability of the economy of the given government to create a tax base - taxable added value.

The U.S. GDP amounts to about 14 trillion dollars. ⁽³⁾

The full tax burden as the amount of all taxes - from the proceeds to cash in the pocket (income tax, dividend tax, individual income tax, etc) – makes about 30% of this amount. ⁽⁴⁾

In this case, it is quite obvious that high tax rates cause flights of industry to other jurisdictions, while low rates lead to a weakening of the ability of the government to perform its functions, including the most important ones - the protection of borders and maintenance of order in the sovereign territory. This is why tax rates in the U.S. are a publicly debated matter and vary depending on the economic situation and expression of public will.

Thus, domestic demand for the amount of circa $4 trillion annually is produced only by the taxpayers generating added value.

Can this demand on the part of taxpayers decrease?

Theoretically, it can – if effectiveness of the IRS drops and the taxpayers (corporations and individuals) get away with concealing their income and evading taxes from such income.

However, in practice it is quite unlikely. One of the most known American proverbs states something like this: "Two things are certain to happen: you will die and you will pay taxes." This shows how effective the U.S. tax system really is. Besides, fortunately for the USA, no prerequisites for reduction of its effectiveness have yet been observed.

It is also worth noticing that the penalty for tax evasion is very tough, investigations on tax crimes are carried out entirely without compromise, and the U.S. judges issue warrants for arresting unscrupulous taxpayers trouble-free, as if on a conveyor.

America knows how to collect taxes, and is unlikely to unlearn. But are there any risks of reduction of the tax base? Will the U.S. economy continue to produce added value at least to the old extend?

Ex-Secretary of State Condoleezza Rice once said: "The wealth of America will increase through new technologies."

Why can one be confident that it is the USA where new technologies will continue to develop most actively?

Because the USA have a huge database of scientific research (R&D) works and development of R&D is a real national priority. It is not a secret for the expert community that RAND Corporation ⁽⁵⁾ , being by its range of activities the largest research and development institute, de facto defines directions for the development of the United States as a nation, and generates the strategy of development, primarily in accordance with prospects for the development of scientific and technological progress.
Because it is only in the USA that one can be quite fast to raise funding for putting into trial operation of the most, one should think, fantastical inventions.
It was in the USA that a brilliant financier, Michael Milken, created a market of "junk bonds" which de facto represents a steady and reliable funding mechanism for advanced developments in the high-tech industry.

How did it work and how does it work?

An inventor or a scientist comes to an investment fund and tells about his or her development or discovery.
The investment fund performs an expert estimation of the proposal. Then, if the project has chances for success, a decision on the issue of securities is made, their prospectus is issued and shares are placed in the market with a great discount – this is why such securities are called “junk bonds”.
There is always a demand for such securities, because there are always stories of success achieved when investments in some sort of “apple” company would end up for investors with a huge profit.
The capital received from placing of shares is enough at least for bring the development to the stage when it becomes clear whether there will be an outcome or not.
If it turns out to be promising, the capitalization of the project instantly grows and rewards the investment fund and investors, as well as the inventor him- or herself. If it does not - well then, a successful startup of even one project out of many may recompense all costs and losses over and above.

This mechanism allows fast attraction of financial resources for further development up to the stage of a trial operation of any more or less valuable invention.

Such a market which has been formed so far only in the USA, offers inventors a colossal "vertical mobility" ⁽⁶⁾, and, most importantly, enjoyment from the "release of their offspring".

This market not only gave a boost to the investment and financial segment, but also provided a rapid breakthrough in the development of new high technologies and the U.S. economy in general. Besides, not only it provided a breakthrough but it formed a permanent trend and set focus on faster and steady development of the segment of cutting edge and hi-end technologies.

There is no reason to believe that this ability of the U.S. economy to produce added value through the development of new technologies will run out in the nearest time –it will rather be contrariwise, since the established institutions of venture financing only improve and develop.

The need for settlement with the government when buying government-owned property.

This factor of creating a demand for national currency is not so significant, and "works" in the case of privatization of a large enterprise by the government, which is unlikely. The degree of "being governmental" of the economy is very low and makes only 28% ⁽⁷⁾

The need to dispose of, in particular, government supported means of payment of any debt or performance of any payment in the territory of the given country.

This problem is especially relevant at the high risks of a disputable situation which may occur in the course of a transaction (payment). If there is a high probability of settling of the dispute through court, then the payment with improper means of payment can become a serious argument against the payer. However, this factor directly depends on the strength and stability of the state. In the time of unrest and a possible change of the power, the above factor works against the national currency but in favour of either such private-law obligations as bills of exchange or bank obligations, or in favour of the commodity natural money.

In the U.S., as it was already mentioned above, taxes can be paid only in U.S. dollars.

Thus, it is obvious that the demand for U.S. dollars is firmly secured in the domestic U.S. market and is protected by an excellent tax administration and a steady growth of the competitive U.S. economy. Besides, it is an economy based on the advanced high-tech segments, little or not at all affected by market fluctuations that are characteristic of economies mainly oriented to primary commodities.

What are the factors of the world demand for the U.S. currency?

The hoarding demand for currency arising as a result of a greater confidence in the powerful government than in other issuers.

Such demand usually occurs when credibility of the home government or its ability to hold the inflation in leash is considerably lower than the credibility of another country’s government. The total disappointment of Russians in the Russian rouble as a store of value is an example of such occurrence. This distrust arose, in particular, as a consequence of the Pavlov’s reform which abolished the circulation of 50-rouble and 100-rouble banknotes on the non-compensation basis and grew as a result of the multiannual chronic inflation (and sometimes even hyperinflation), regularly devaluing both cash and non-cash Russian national currency.

Such problems never emerged in the USA, and there is hardly a person to believe that scenarios, similar to those that took place in Russia, can ever be realized in the USA.

The hoarding demand for currency arising as a result of a greater credibility of a government which is capable of maintaining a reliable and operational banking system.

For example, total collapse of the Russian banking system in 1998 did not contribute to developing a habit of long-term depositation of money in the form of fixed deposits in roubles.

A number of experts ⁽⁸⁾ believe that the main reason for bank crises is not so much the violent fluctuation of prices for property (for mortgage banks), shares (for investment banks), currency etc, as, first of all, poor performance of regulatory functions by the government allowing disproportions in the banks’ credit portfolios in one or another industry of economy.

In the USA, for example, after the 1930-1933 crisis, banks were prohibited to acquire shares by law.

Thus, we can conclude that the hoarding demand for the U.S. dollars is great by virtue of the relative stability as of the political system, so of economy and the finance the USA.

Besides, it can only grow during the periods of global instability, when the number of countries with disequilibrium of economy grows.

Comfortable currency law

If a government prohibits circulation of its currency abroad, then it is hard for it to hope that citizens and companies from other countries will accumulate this currency.

At the same time, the USA actively promote and protect the U.S. dollar as an international means of payment and this policy brings tangible results. For the moment, no one was able to form an alternative to the dollar as an international means of payment and savings.

(1) Find more details in “The institutional theory of money” by A. Yu. Gribov, page 163.

(2) http://www.irs.gov/businesses/small/article/0,,id=130524,00.html

(3) http://www.census.gov/compendia/statab/2010/tables/10s0655.pdf

(4) http://www.whitehouse.gov/sites/default/files/omb/budget/fy2009/pdf/hist.pdf page 317

(5) RAND (Research and Development) — a U.S. strategic research center. Its field of concern is assistance to the scientific, educational, and charity activities in the interest of the social welfare and national security of the USA. The center develops and identifies new methods of analyzing strategic problems and new strategic concepts.

(6) Vertical mobility is a change in the position of an individual which causes an upgrading or downgrading of his or her social status.

(7) http://ru.wikipedia.org/wiki/Экономика_США

(8) and the author himself