When the Dollar is no Longer the World’s Reserve Currency

KEY POINTS

• The U.S. dollar has been the world’s major reserve currency for decades, but that status could come under threat as “very powerful countries” seek to undermine its importance, warned Anne Korin, from the Institute for the Analysis of Global Security.
• Korin says China, Russia and the European Union are some “major movers” behind this push.
• One of those reasons driving their shift away from the dollar is the prospect of being subject to U.S. jurisdiction if they transact in dollars.

The U.S. dollar has been the world’s major reserve currency for decades, but that status could come under threat as “very powerful countries” seek to undermine its importance, warned Anne Korin, from the Institute for the Analysis of Global Security.

“Major movers” such as China, Russia and the European Union have a strong “motivation to de-dollarize,” said Korin, co-director at the energy and security think tank, on Wednesday.

“We don’t know what’s going to come next, but what we do know is that the current situation is unsustainable,” Korin said. “You have a growing club of countries — very powerful countries.”

To be sure, the dollar is seen as one of the safest investments in the world, and it rises during times of economic or political tumult.

But one factor curbing countries’ enthusiasm for the greenback is the prospect of being subject to U.S. jurisdiction when they transact in dollars. When the U.S. dollar is used or transactions are cleared through an American bank, entities are subject to U.S. jurisdiction — even if they have “nothing to do with the U.S.,” Korin told CNBC’s “Squawk Box.”

Korin cited Washington’s unilateral withdrawal from the Iran nuclear deal in 2018, which was followed by the restoration of sanctions on Tehran. That situation left European multinational companies vulnerable to punishment from Washington if they continued to do business with Iran.

“Europe wants to do business with Iran. It doesn’t want to be subject to U.S. law for doing business with Iran, right?” she said. “Nobody wants to be picked up at an airport for doing business with countries that the U.S. isn’t happy that they’re doing business with.”

As a result, countries have a “very, very strong motivation” to shift away from using the greenback, she said.

‘Petro-yuan’ may be an early warning

But if the dollar declines in influence, other currencies could fill the role traditionally played by the greenback — especially China’s yuan.

In recent years, China has tried to internationalize the use of its currency, the Chinese yuan. Such moves have included the introduction of yuan-denominated crude oil futures and reports that China is preparing to pay for imported crude in its own currency rather than the U.S. dollar.

Yuan-denominated oil futures — also referred to as “petro-yuan” — could serve as an early warning sign for the dollar’s waning dominance, Korin said.

“I think it’s a canary in the coalmine. Look, 90% of … oil is traded in dollars,” she said. “If you have a sort of a beginning to crumble away (at) the dominance of the dollar over oil trade, that’s a nudge in the direction of de-dollarization.”

However, she added that while the petro-yuan may be a “necessary” condition for the international abandonment of the dollar, it’s “not sufficient” to make it happen on its own.

Coutesy of CNBC by Eutance Huang

PUBLISHED WED, OCT 30 20197:27 PM EDT UPDATED THU, OCT 31 20191:35 AM EDT

With our national debt blowing past 23 trillion dollars nothing is as sobering as looking at future budgets. We should be worried. Central banks across the world claim the lack of inflation is the key force driving their QE policy and permitting it to continue, however, the moment inflation begins to take root much of their flexibility will be lost. This translates into governments being forced to pay higher interest rates on their debt. For years the argument that “This Time Is Different” has flourished but history shows that periods of rapid credit expansion always end the same way and that is in default. This also underlines the reality that any claims Washington makes about the budget deficit being under control is a total lie.

America is not alone in spending far more than it takes in and running a deficit. This does not make it right or mean that it is sustainable. Much of our so-called economic growth is the result of government spending feeding into the GDP. This has created a false economic script and like a Ponzi scheme, it has a deep relationship to fraud.

Global debt has surged since 2008, to levels that should frighten any sane investor because debt has always had consequences. Much of the massive debt load hanging above our heads in 2008 has not gone away it has merely been transferred to the public sector where those in charge of such things feel it is more benign. A series of off-book and backdoor transactions by those in charge has transferred the burden of loss from the banks onto the shoulders of the people, however, shifting the liability from one sector to another does not alleviate the problem.

When the 2018 financial year budget was first  unveiled it was projected to be $440 billion. An under-reported and unnoticed later report painted a far bleaker picture. The report titled the “Mid-Session Review”

2019_AmericanBudget_Mid-SessionReview

  forecast the deficit much higher than originally predicted. The newer report predicted the deficit would come in at $890 billion which is more than double what they predicted in March of 2017.

Such a miss would bring up the question of whether the discrepancy in the 2018 budget is an outlier or a sign of incompetence. This is especially troubling because what was projected as a total budget deficit of $526 billion for 2019 Fiscal Year has now been revised to a staggering $1.085 trillion. Not only should the sheer size of these numbers trouble us but we should remember that until recently some Washington optimists were forecasting that deficits would begin to decline in 2020 and that we would even have a small surplus of 16 billion in 2026. The updated revisions have washed away this glimmer of hope and replaced it with more trillion-dollar deficits going forward.

Interestingly, the summery that begins on page one of the Mid-Session Review comes across as a promotional piece using terms like MAGAnomicics that praise and tout the Trump administration for its vision and great work. This is a time when it would be wise to remember numbers don’t lie but the people using them do. This report is an example of how they re-frame a colossal train wreck into something more palatable. The report even goes so far as to assure us that the deficit will fall to 1.4 percent of the GDP in 2028, from its current 4.4 percent.As a result of the American economy having survived with little effect what was years ago described as a financial cliff we have become emboldened and now enjoy a false sense of security. Today instead of dire warning we hear news from Washington and the media how the stock market continues to push into new territory and all is well.

The chart to the right predicted that by 2019 the national debt would top 12 trillion dollars, not the current 23 trillion. Projections made by the government or any group predicting budgets based on events that may or may not happen at some future date are simply predictions and not fact. This means that such numbers are totally unreliable. The ugly truth many people ignore is that starting last year entitlements became the driving force that will carry the deficit higher and higher into nosebleed territory. Even though we have seen deficits reach unprecedented levels the deficits in our future will be dramatically worse.

It isvery disturbing that so many people have forgotten or never taken the time to learn recent financial history. By recent, I’m referring to the last fifty to one hundred years. The path that Fed Chairman Paul Volcker set right decades ago has again become unsustainable and many people will be shocked when this reality hits. Do not underestimate the value of insight gained from decades of economic perspective. It tells us the economy of today is far different from the way things have always been.

Back in September of 2012, I wrote an article reflecting on how the economy of today had been greatly shaped by the actions that took place starting around 1979. Interest rates, inflation, and debt do matter and are more significant than most people realize. Rewarding savers and placing a value on the allocation of financial assets is important. It should be noted that many Americans living today were not even born or too young to appreciate the historical importance and ramifications of the events that took place back then. The impact of higher interest rates had a massive positive impact on corralling the growth of both credit and debt acting as a crucial reset to the economy for decades to come. Below is a copy of that article.

A Time For Action, 1980?

In his book “A Time For Action” written in 1980 William Simon, a former Secretary of the Treasury tells how he was “frightened and angry”.  In short, he sounded the trumpet about how he saw the country was heading down the wrong path. William Simon (1927 – 2000) was a businessman and a philanthropist. He became the Secretary of the Treasury on May 8, 1974, during the Nixon administration and was reappointed by President Ford and served until 1977.

I recently picked up a copy of the book that I had read decades ago and while re-reading it I reflected on and tried to evaluate the events that brought us to today. As often the future is unpredictable, looking back, it is hard to imagine how we have made it this long without finding long-term solutions and addressing the concerns that Simon wrote about so many years ago. Back then it was about billions of dollars of debt, today it is about trillions of dollars. It appears that something has gone very wrong.

Do Not Underestimate The Importance Of The Reset By Paul Volcker In 1980

By the end of the 70s inflation started to soar. Only by taking interest rates to nosebleed levels was then Fed Chairman Paul Volcker able to bring inflation back under control. Paul Volcker, a Democrat was appointed as Federal Reserve chairmanby President Carter and reappointed by President Reagan. Volcker is widely credited with ending the stagflation crisis where inflation peaked at 13.5% in 1981. He did this by raising the fed fund rate which averaged 11.2% in 1979 to 20% in June of 1981.  This caused the prime rate to hit 21.5% and slammed the economy into a brick wall. This also affected and shaped the level of interest rates for decades

Rates Today Are Ready To Fall Off The Chart!

This action and the increased interest rates in following years is credited by many to have caused  Congress and the President to eventually balance the budget and bring back some sense of fiscal integrity and price stability to America. As the debt from the Vietnam war and soaring oil prices became institutionalized we moved on. Interest rates slowly dropped and the budget came under control. In recent years spending has again started to grow and at the same time taxes have been cut. This has slowly occurred over years and been ingrained in the system.

With our debt at 23 trillion and growing the path has again become unsustainable and many people will be shocked when the reality hits. As our debt climbs some Americans feel just as frightened and angry as Simon did so many years ago. America has kicked the can down the road, failing time and time again to face the tough decisions. Part of the problem is the amount of debt has grown so large that we can no longer imagine or put a face on it. The day of reckoning may soon be upon us, how it arrives is the question. Many of us see it coming, but the one thing we can bank on is that when it arrives many will be caught totally off guard.

Authored by Bruce Wilds via Advancing Time blog,

Having warned in the past that central banks’ ability to reverse an economic downturn is coming to an end (just as the global economy enters what he says are the late stages of the long-term debt cycle), Billionaire hedge-fund founder Ray Dalio warned today that the global economy is under threat from an explosive mix of ineffective monetary policy, a rise in the wealth gap and climate change.

This combination, according to the Bridgewater Associates founder – the world’s largest hedge fund – will lead to a “scary situation” over the next decade…

“The technology and increasing use of artificial intelligence and increased productivity will also substantially increase the wealth gap, the job gap, the wealth and ideological conflicts within countries.”

This brief comment fits with Dalio’s previous warning that there are “three big forces” for investors to watch:
the point where there’s an economic downturn and central banks can’t cut interest rates further and their asset purchases cease being effective,
when rising inequality sparks “extreme” conflicts between the rich and poor,
and the battle for global dominion between the rising power of China and the incumbent world power, the US.
Concluding that if/when there is an economic downturn, that will produce serious problems in ways that are analogous to the ways that the confluence of those three influences produced serious problems in the late 1930s.
Regarding the above analog and where we are now, in my opinion, the most important things that are happening (which last happened in the late 1930s) are
a) we are approaching the ends of both the short-term and long-term debt cycles in the world’s three major reserve currencies, while
b) the debt and non-debt obligations (e.g. healthcare and pensions) that are coming at us are larger than the incomes that are required to fund them,
c) large wealth and political gaps are producing political conflicts within countries that are characterized by larger and more extreme levels of internal conflicts between the rich and the poor and between capitalists and socialists,
d) external politics is driven by the rising of an emerging power (China) to challenge the existing world power (the US), which is leading to a more extreme external conflict and will eventually lead to a change in the world order, and [Ian Bremmer calls this the return of a bi-polar world but with significant differences in the goals of the powers—JM]
e) the excess expected returns of bonds is compressing relative to the returns on the cash rates central banks are providing
As for monetary policy and fiscal policy responses, it seems to me that we are classically in the late stages of the long-term debt cycle when central banks’ power to ease in order to reverse an economic downturn is coming to an end because:
Monetary Policy 1 (i.e. the ability to lower interest rates) doesn’t work effectively because interest rates get so low that lowering them enough to stimulate growth doesn’t work well,
Monetary Policy 2 (i.e. printing money and buying financial assets) doesn’t work well because that doesn’t produce adequate credit in the real economy (as distinct from credit growth to leverage up investment assets), so there is “pushing on a string.” That creates the need for…
Monetary Policy 3 (large budget deficits and monetizing of them) which is problematic especially in this highly politicized and undisciplined environment.
More specifically, central bank policies will push short-term and long-term real and nominal interest rates very low and print money to buy financial assets because they will need to set short-term interest rates as low as possible due to the large debt and other obligations (e.g. pensions and healthcare obligations) that are coming due and because of weakness in the economy and low inflation.
Their hope will be that doing so will drive the expected returns of cash below the expected returns of bonds, but that won’t work well because:
a) these rates are too close to their floors,
b) there is a weakening in growth and inflation expectations which is also lowering the expected returns of equities,
c) real rates need to go very low because of the large debt and other obligations coming due, and
d) the purchases of financial assets by central banks stays in the hands of investors rather than trickles down to most of the economy (which worsens the wealth gap and the populist political responses).
This has happened at a time when investors have become increasingly leveraged long due to the low interest rates and their increased liquidity. As a result we see the market driving down short-term rates while central banks are also turning more toward long-term interest rate and yield curve controls, just as they did from the late 1930s through most of the 1940s.

By Tyler Durden ZeroHedge