King Dollar

Whilst heightened uncertainty and fear grips savers and investors in global financial markets, some unlikely bedfellows—namely China, Saudi Arabia, and Iran—are discussing a closer economic and strategic alliance: a direct repost to US foreign policy in the region. At the same time, the most powerful emerging economies (BRICS) have grown tired of living under the weaponization of the USD and further threats of bilaterally imposed sanctions and are actively seeking to challenge the status of the US as the world’s reserve currency. Speculation and rumours are rife, and whilst it makes for fascinating discussion and debate, is replacing the USD wishful thinking or reality?

John Maynard Keynes was the leading economist of his day. In 1944, through sheer force of personality, he convinced the Bretton Woods Conference to peg the US dollar to gold at 35 USD a troy ounce. Other currencies were expected to follow its lead. In 1971, however, President Nixon took the US dollar off the gold peg, allowing it to find its free-floating level in the market. This is the FIAT system we have today, under which the US dollar is the principal unit of account for goods, services and finance worldwide. The Bank of International Settlements (BIS) reports that the global daily average of transactions is 6.6 Tr USD. Ninety percent of all trading of goods, services, and financial transactions are denominated in US dollars. The euro, yen and sterling account for a fraction, with the Chinese yuan at perhaps 1%.

US dollar reserves held by central banks have fallen from 70% to 50% during the last 20 years. Whilst this is clearly a trend, it has taken 20 years to fall 20%. There is much talk and speculation of a basket made up of gold and commodities, much like the Self Drawing Rights (SDRs) held and used by the IMF. Many commentators in the US cite the aggression of China in manipulating its own currency and imposing capital controls on the flow of currency. The US dollar index has lost 16% since October 2021; in contrast, gold measured in US dollars has gained 20% over the same period.

As much as non-USD economies want to get out from under US dollar domination, there is no other currency close to being internationally tradable. For all their rhetoric on the international stage, the People’s Republic of China is a closed economy, and very few foreign financial intermediaries now operate there. Although in addition to the US domestic money supply, the so-called ‘shadow banking system’ operates on euro–dollar swaps, this market dwarfs the existing US domestic money supply, is unregulated and consists mainly of leveraged derivatives, which Warren Buffer famously described as financial weapons of mass destruction. The USD issuance in this market is opaque and only adds to USD dominance.

With such a wide protective moat, and lack of any credible alternative, the US dollar will continue to hold the world’s reserve status for the foreseeable future—until a second Bretton Woods Conference is convened. Central bank holdings of gold bullion will be key to the outcome. However, a Trojan horse of excessive debt, deficits, and unfunded liabilities threatens the US dollar from within and the US Dollar and will eventually, as with all FIAT currencies depreciate as confidence evaporates.

Jeremy Blatch TEP
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