The recent rise in interest rates, in response to the threat of Fed tapering, foreshadows the unavoidable demise for the dollar. Not only did the rise in rates have an immediate effect on the housing recovery, it also indirectly exposed the system to another vulnerability, that is, the Fed is not only the lender of last resort but will be the lender to the spender of last resort — the U.S. Treasury.
That all fiat currencies end the same is no secret.
Reserve currencies are not immune. Slowly, the status of the dollar as reserve currency is slipping away. Rumblings of a re-arranging of trade status are approaching a feverish pitch.
The U.S. Reaction
It is often noted that in a race to debase or outright move away from dollar trade, the U.S. would simply punish those who attempt to trade around the reserve currency. There is only so much force the U.S. could employ to punish other sovereigns for moving away from the dollar.
A large enough alliance of U.S. creditors could gradually reduce their exposure to U.S. denominated debt. They could stop accumulating or either let current bills mature without rolling them over. Much of the U.S. power has come from the enormous privilege of being the reserve currency.
Certainly, the precedent is well established for moving outside of the reserve system.
Reserve currency status in a world where every other currency is also debt affords very little protection. In an electronic world, the race to the end or a switch to a new reserve could happen with very little notice.
We've never had a fiat reserve.
Just as every fiat currency has fallen in the past, the same goes for every reserve currency. What makes the dollar special is that we are living through the last 1% of its purchasing power. As soon as the Romans began debasing the denarius (a one time physical reserve currency), it was only a matter of time until the reserve status of that currency vanished.
The search for an intermediate-term signal should center on the U.S. bond market. The bond market is truly the elephant standing in the center of the great fiat Ponzi.
Short-term debt is used as collateral for the keeping the trillion dollar per day REPO market functioning. Intermediate to longer-dated treasuries serve as the spending source which keeps the government open. The U.S. depends not only on low interest rates to afford interest payment but also captive domestic buyers and, more importantly, foreign investors.
When those buyers shy away as interest rates rise, the death spiral of the dollar may be on its way. When the bond market begins to crash, the Fed (now in it for the banks) will be forced by the Treasury to step in.
Political support will not waver, as both sides disregard current debt and, especially, unfunded liabilities. Taxes will not be enough without real growth. Government spending will be the vehicle for bidding up prices — not the cash-strapped consumer.
The fact that people don't have enough money in a hyperinflation will not matter as the government will bid up prices as money velocity kicks in.
At this point the U.S. Federal Reserve has run out of options. It is left only with a perceptual game of deception. If there were any other option they would take it. As an intermediate term signal for the end of the dollar, the U.S. bond market is the canary in the coal mine.
The time to prepare is now, while it's still possible to walk into a coin shop and buy precious metals as a hedge against disaster.