Why Villa Diodati? Two famous manuscripts were drafted there: The Modern Promethus (a.k.a. Frankenstein) by Mary Shelley, and The Vampyre by Lord Byron and Polidori.  After all, the villa is not far from Geneva, the intellectual birthplace of the most famous revolutions: the American and French Revolutions that took place just 40 and 27 years (respectively) before the completion of The Modern Prometheus/Frankenstein. The year 1816 is known as “the year without summer.” The eruption of a volcano in Indonesia polluted the atmosphere, caused temperatures to drop significantly, brought extreme weather phenomena, and in general, wreaked havoc around the world. The summer of 2020, like the summer of 1816, was quite abnormal as well, and as the fall season came upon us, voices proclaiming an imminent collapse in the dollar multiplied.

As the discussion started, the group (led by well-respected analysts) that advocates a dollar crash offered important arguments/facts that could be summarized as follows:

• The US, by controlling the dominant reserve currency in the world, has been enjoying an exorbitant privilege of an over-extended standard of living at the expense of other countries. It’s time for that privilege to be withdrawn and the world will demand immediate concessions like in the late 1960s/early 1970s and in 1985.
• The US current account deficit (primarily the trade deficit) is unsustainable.
• The US budget deficit is also unsustainable.
• Despite the fact that the US households and corporations enjoyed record savings during the C-19 crisis, aggregate net domestic savings has collapsed into negative territory.
• In order to sustain its over-extended standard of living, the US keeps borrowing surplus savings from abroad. If foreigners refuse to lend the US, the dollar will collapse.
• Even before C-19, the net domestic saving rate averaged about 3% between 2011 and 2019, which is less than half of the saving rate recorded between 1965 and 2005. Such a thin cushion leaves the US and the dollar very vulnerable to shocks, let alone another crisis.
• Budget deficits are expected to remain very high (e.g. close to 9% in 2021), exercising downward pressure on net savings, and consequently on the dollar.    
• Given the need for infrastructure spending, the funds needed to address concerns of an aging capital stock will require further liquidation of savings in order to expand productive capacity. Further borrowing from abroad is required for growth to materialize, however the attractiveness of higher US interest rates is not there, given the dominance/commitment of a zero-rate policy. As twin deficits (current and budget) rise, the dollar will continue to be pressured downward.
• Inflationary fears will push the dollar further down.  
• The effective real exchange rate of the dollar against a basket of currencies signifies overvaluation by at least 25%.
• The Next Generation EU Fund of about $850 billion raised the flag of an alternative to the dollar. The renminbi and cryptocurrencies appreciation in the last few months are indicative of additional alternatives and of what is forthcoming for the dollar.
• In the previous historic incidents of the dollar’s fall (1970s and mid 1980s), the greenback lost 33 and 28% respectively against major currencies of that era. This time, the dollar will drop by 25-35% by the end of 2021.  
• As confidence returns to the world economy, opportunities outside the US will flourish, and US capital will migrate there as the non-US risk appetite rises, adding to the downward pressures on the dollar. 
• The dollar made significant gains as the C-19 crisis erupted but gave up those gains and even more in subsequent months as the world learned to live with C-19 and the original Frankenstein-type scenarios did not materialize.

There is little doubt that the arguments outlined above make economic sense, have sound theoretical and even some empirical evidence behind them and raise a red flag as to whether indeed a dollar crash is imminent. However, and with all due respect to the advocates of such a view, our humble opinion is that such arguments do not take into account the historical evolution and the context of today’s circumstances. Here is then a list of counter-arguments presented at Villa Diodati.

• TINA (There Is No Alternative) is a fact of life. Paraphrasing Harry Dexter White in his famous debates at Bretton Woods in the summer of 1944: “Do you want gold to be the international reserve standard? Then, show me your gold. The fact is that you have no gold to show off, given that 69% of the global gold reserves are in Fort Knox, Kentucky as well as in a couple of other places in the US. My dollar is as good as gold and that’s why the world has to accept the dollar as the international reserve currency and standard.” In the immediate aftermath following the decision to abandon the Bretton Woods Agreement – the decision was made on a Friday but was announced on Sunday – on Friday August 13^th, 1971 (hello Frankenstein), the US dollar lost some ground, which was followed by havoc in the international markets (oil prices went from $2 to $20 a barrel within 3 years and eventually to $40 within 8 years), stagflation prevailed, geopolitical crises erupted, and the markets collapsed. Order was not restored until Paul Volcker was appointed Chairman of the Fed. Since Paul Volcker established the foundations of the modern economies – in the sense that we learned to operate and conduct our complex trade and capital flows transactions using fiat money – the dollar continues and will continue to be the dominant reserve currency on planet earth. The fact that 62% of global reserves are in dollars signifies the reality of TINA.   
• The return of great power rivalry – to use the title of the excellent book by Matthew Kroenig – is a return to a familiar power rivalry, i.e., we have seen that movie before. It’s a power rivalry between a mega-power (US) with solid democratic foundations and a tyrannical power (the USSR back then, and China now). If you go back to thousands of years of history – as Matthew Kroenig does in his book – you will observe one consistent theme: democratic forces and power thrive over tyranny and autocracy.
• If the dollar crashes, US bond rates will increase, which in turn will attract capital to the US due to favorable interest rate differentials, which in turn will boost the value of the dollar.
• A dollar crash, will create much greater turmoil in global markets, which as in all similar cases (just recall the financial crisis of 2008 and C-19) will be a march to the safe haven called the dollar, lowering the cost of financing the “exorbitant privilege”.
• Do we really doubt the power of the Fed to protect the dollar? The legacy of Paul Volcker is still alive and well, including the incoming administration of President-elect Biden (let’s not forget that Volcker was Chairman of the Economic Recovery Board in the White House between 2009-2013).
• The US does not view China’s holding of US Treasuries as a threat in terms of giving the Chinese any leverage. Do they wish to dump the US bonds? It will be their loss and our gain. Our challenge to them is: “Go ahead, and try it, and make our day!”
• The maturity restructuring of US debt, allows room for maneuvers that will lower the cost of financing the debt.
• There is complex balance of forces at play in the debt/bond markets. A potential increase in bond yields due to higher growth (higher consumer spending, higher wages, lower unemployment, more infrastructure spending, and even a modest increase in inflationary expectations) will attract more capital flows to the US. Higher capital flows will translate to the strengthening of the dollar. 
• An upswing in US bond yields will signify a return to normalcy, will help pension funds, and will send the signal to global investors that US markets are deep, functional, liquid, and they can trust them not just as safe havens but also for modest returns.
• If need be, the US can issue again the Robert Roosa bonds (Volcker’s mentor), as it has done in the past. These bonds can be nonnegotiable/non-tradeable financial instruments, issued by the US Fed, denominated in foreign currencies, and sold to foreign central banks. These bonds can transform a portion of dollar holdings of foreign central banks into longer-term debt that is protected from a dollar’s fall and thus designed to protect the financial markets from a currency crisis and the local central banks from losses originated by a drop in the value of the dollar. The issuance of such bonds signifies to the global markets a commitment to protect the value of the dollar, while absorbing their currency risk. Needless to say, that the issuance of such bonds would prop up the value of the dollar.
• Also, and with all due respect to the EU leadership, the issuance of bonds in order to support the Next Generation Fund does not signify a banking union nor a fiscal union, both of which are fundamental components of a viable, sustainable, and functional fiat currency.    

Dear friends, almost 150 years before Mary Shelley drafted Frankenstein in this very same villa, John Milton visited the villa to be inspired of a Paradise Lost, showing us all that a meditation to rebellion (Prometheus) requires enlightened eyes that can clearly see that heroes of celebrated unprincipled growth based on tyrannical cheating could be just villains thirsty to subjugate and convert us all into a Frankenstein. Milton taught us that a desire for redemption is met when the fallen victim finally emerges as a hero.