The Dollar Milkshake that Brings the Bucks to the Yard

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Playing board games with highly competitive people is a thrilling experience. When individuals place an irrational amount of value in winning a children's game, dynamics emerge that are both terrifying and laughable. Growing up one of my favorite board games was Monopoly. When I played Monopoly with highly competitive people there would be weird economies that emerged. The players would begin to trade real world favors, real world money, and leverage real world relationships in order to improve their status in the game. When a game of monopoly ended, the value of the real world assets that were accumulated did not factor into deciding the victor. The winner of the game was always the person who achieved the in-game monopoly, rather than the person who accumulated the most “real value.”

When the US dollar became the world reserve currency, every country needed to have US dollars in order to conduct international trades. This has not changed. If I sound like a broken record mentioning this fact it is because of its importance in understanding and explaining current global economic conditions. We can look at global economics as a giant unending game of monopoly. Each country wants to win and the winner in any given moment is determined by the country who controls the most valuable parts of the board. In this global game US dollars are the monopoly money. The amount of their own currency other countries produce, the side deals other nations have with each other, and the amount of goodwill they have accumulated do not matter. At the end of the day every nation requires US dollars in order to play the game. This, in effect, makes the United States both a player in this game of monopoly and the banker. And so far we have no qualms about cheating.

Most of the predictive economic theories that I have come across recognize this dynamic as the basis for where the global economy may head in the future. However, there is a clear divide between the “economists” who believe there will be a long period of inflation and the ones who believe that secular deflation is the most likely outcome. The most compelling deflationary theory that I have seen so far is the Dollar Milkshake Theory created by Brent Johnson.

Before the Eurodollar system collapsed, foreign and domestic banks were able to create their own liquidity via accounting tricks and traded bank liabilities. After the collapse of the Eurodollar system, central banks globally were forced into the role of US dollar liquidity provider and dollar liquidity backstop for their prospective countries. The way global central banks create liquidity is by printing their own currency and using that currency to purchase US dollars. Brent Johnson describes central bank money printing as creating a milkshake of liquidity. Every dollar of every currency printed goes into the US dollar milkshake.

Since nearly all foreign trade is conducted using US dollars, the majority of international debt is also denominated in US dollars. If a central bank stops printing money, they will not be able to maintain dollar reserves, trade, or service their dollar denominated debt. They will also lose access to liquidity, meaning no more sipping from the milkshake. This will result in that country defaulting on their debts and eventually it will cause its economic collapse. This is the reality for every major central bank in the world including the United States Federal Reserve system. Their only other option is to keep printing. Printing money is inherently inflationary. The more of a good there is, the less each individual unit of that good is worth. In my understanding, Brent Johnson agrees that central bank money printing will be inflationary for every country... except the United States. The crux of the Dollar Milkshake Theory is demand.

If Japan and the United States each print money in similar amounts, their currencies should also inflate by similar percentages. But since there is high demand for US dollars and there is considerably less demand for Japanese yen, the value of yen will fall further than the value of dollars. Continued money printing by both parties will magnify this effect. In this instance the Japanese economy will decline relative to the US economy. The only way to prevent a higher decline of the Japanese yen is for the US to print more than Japan. Theoretically, this will also result in higher economic growth in the United States relative to Japan. Regardless of a central bank’s strategy for money printing, the result is always the same. The United States economy grows relative to the global economy. The US dollar becomes stronger. They become more expensive… deflation.

Countries need liquidity and investment the most when their economies are in decline. Revisiting Japan, whose currency has inflated relative to US dollars, the investors in the Japanese economy will see the United States as a safer place for their money and Japan will experience capital flight. They will be losing liquidity when they need it the most, and it will all be flowing into the United States economy causing a further increase in the value of US dollars and a further decrease in Japanese yen.

But Japan is not a closed economy, and it is not the only country who requires US Dollars. A slow down in any major country’s economy will cause an increase in the price of US dollars globally, forcing every central bank to print more of their own currency in order to keep up with their demand for US dollars. The cycle of currency inflation to slowed economic growth to capital flight will proliferate and cascade through every major country and cause recessions in every major economy. The US will feel the effects of the global recession, but one major difference will be that our currency will be appreciating. Our economy will appear to be strong. Brent Johnson equivalates this to the United States sucking up the liquidity milkshake that was created by global money printing. No one else gets a straw.

This sounds like great news for the United States. America, Fuck Yeah. The issue is that the United States economy can not sustain itself without a strong global economy. Since the US holds the world reserve currency we may be the last to fall, but we will fall. After the US has finished the entire milkshake, the following recession will likely be more catastrophic than any the world has ever seen. What's more, the recessions in the other economies around the world will likely have geopolitical consequences that will be detrimental to the United States long term. When it is all said and done, there will be no winners…