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

By Simon Black on February 2, 2019

We write a lot about global debt levels at Sovereign Man.

In fact, the very first Notes from the Field I ever wrote, in June 2009, was about how broke the US was… and the severe consequences that eventually face a nation that recklessly spends money it doesn’t have.

And debt has been a major theme in this publication ever since.

As you know, since the Great Financial Crisis in 2008, debt levels have only gotten worse. But not just for governments.

Sovereign debt, corporate debt and consumer debt are all at all-time highs.

The US government has $22 trillion of debt and is running $1 trillion+ deficits every year. There’s a record $15 trillion of corporate debt. And the US consumer has racked up around $4 trillion of debt (not including mortgages).

And you don’t have to take my word for it that this is all going to end badly…

Last week, one of the most respected hedge fund managers in the world came out with a warning scarier than anything we could have dreamed of.

Seth Klarman runs the $28 billion hedge fund, Baupost Group. The guy is famously secretive (and conservative). So the fact that he went out of his way to make this public statement means you should pay attention.

Also, Klarman’s fund is closed (he’s actually been returning money), so he’s not doing this to scare people into investing in his fund.

In a 22-page letter to his investors, Klarman warned that government debt levels, particularly in the US (where debt exceeds GDP), could lead to the next global financial crisis.

“The seeds of the next major financial crisis (or the one after that) may well be found in today’s sovereign debt levels,” he wrote.

In addition to debt levels, Klarman is worried about the increasing social unrest (something we’ve written about in detail) and the public’s inability to decipher who is telling the truth these days between politicians and the media… both of which make it difficult for a capitalist system to thrive.

Who knows what will ultimately bring the system crashing down, but let’s focus on the US government’s exploding deficits…

In 2018, the federal government’s deficit hit $1 trillion. But these are “good times,” with soaring asset prices, solid corporate profits and record-low unemployment.

What happens when a recession inevitably occurs. Our friend Jim Grant of Grant’s Interest Rate Observer, says the deficit will blow out to $2 trillion.

So, $22 trillion in the whole and a $1 trillion deficit in a good year. Not to mention, interest rates are rising, which means all of this debt is just getting more expensive.

Eventually, people will simply refuse to lend Uncle Sam any more money… because they know there’s no way they’ll be repaid.

And we’re already seeing signs of that.

According to the Wall Street Journal, in the first eight months of 2018, overseas buyers of US Treasurys only bought half the amount they did over the same period in 2017.

From Klarman:

“There is no way to know how much debt is too much, but America will inevitably reach an inflection point whereupon a suddenly more skeptical debt market will refuse to continue to lend to us at rates we can afford…”

And when fewer people want your bonds, that means it’s more expensive to borrow. But the government can’t afford to pay any more…

The government already spends 28% of its revenue just on interest (at a time when interest rates are near all-time lows).

Ultimately, Klarman believes the debt (along with the massive wealth disparity caused by a 10-year asset price boom) will lead to social unrest…

“It is not hard to imagine worsening social unrest among a generation that is falling behind economically and feels betrayed by a massive national debt that was incurred without any obvious benefit to them.”

Again, this isn’t Sovereign Man speaking… it’s a bespectacled hedge fund manager out of Boston.

Another line from Klarman that comes straight from Notes… “By the time such a crisis hits, it will likely be too late to get our house in order.”

But Klarman isn’t the only billionaire alerting the public right now…

At the recent Davos gathering, Ray Dalio, founder of the world’s largest hedge fund, said he thinks the next downturn will be worse than the Great Depression.

And like Klarman, Dalio says the problem comes down to too much debt…

“The biggest issue is that there is only so much one can squeeze out of a debt cycle and most countries are approaching those limits”.

The world is drowning in debt. And there’s no austerity measures in sight. In fact, a rising tide of socialist politicians want to explode government spending (paying for free healthcare, education and everything else under the sun).

We don’t know when this monetary experiment will end. The European Central Bank and Bank of Japan both essentially reneged on their plans to start tightening monetary policy. And yesterday, the Federal Reserve has signaled it will stop hiking rates.

Global central banks, it seems, have already given up on their weak attempts to tighten… fearing the economy wouldn’t hold up.

If they step back on the gas of QE, I believe that’s the point when people lose faith in fiat… and the US dollar specifically.

And while this all goes down, the central banks (who control the printing press) have been buying gold at the fastest pace in years. You may want to consider doing the same.

Gold is one of the few asset classes that hasn’t risen to absurd heights. But it may be coming back to life… the metal rallied to an eight-month high this week.

By Ranjeetha Pakiam on January 7, 2019

• Prices climbed in December on equity rout, growth concerns
• China has previously gone for long periods without buying gold

After a hiatus of more than two years, China is adding to its gold reserves again.

The People’s Bank of China increased holdings to 59.56 million ounces by the end of December, or about 1,853 metric tons, from 59.24 million ounces previously, according to data on the central bank’s website. They had been unchanged since about 130,000 ounces were added in October 2016.

The world’s biggest producer and consumer boosted holdings of bullion in a month marked by mounting concerns that China’s trade dispute with the U.S. is threatening economic growth. Spot gold had its strongest month in almost two years as those fears spurred gyrations in equities and the dollar and boosted demand for the precious metal as a haven.

Speculation that the Federal Reserve may pause its interest rate hikes has given further strength to gold’s rally into the new year and assets in bullion-backed exchange-traded funds are at a seven-month high. Spot gold was trading 0.5 percent higher at $1,291.83 an ounce.

“It’s a bullish sign for gold,” Matthew Turner, a commodities strategist at Macquarie Group Ltd. in London, said by phone.

The Asian nation has previously spent long periods without revealing increases in gold holdings. When the central bank announced a 57 percent jump in reserves to 53.3 million ounces in July 2015, it was the first update in six years.

“I’m always wary of year-end moves, but if they buy again, then it’ll look like they’re on another run of additions, like they did in 2015-2016.” Turner said.

It’s not just China buying. Poland and Hungary surprised the market in 2018 by adding to their gold holdings for the first time in many years. Central banks were expected to increase their purchases of gold in 2018 for the first time in five years as eastern European and Asian countries seek to diversify their reserves, according to an October projection by consultancy Metals Focus Ltd.

by Ross Norman on January 15, 2019

It is natural that we measure things by a familiar yardstick – the problem is that being so-biased or lazy, we can be deceived.

Take gold. Popular belief has it that gold prices have not performed especially well despite some egregious geopolitical and economic factors. Well measured in 72 currencies, gold is at … or within a few percentage points … of being at an all time high for people in those countries. Not on the list are the British Pound, the Swiss Franc, the Euro and Chinese Yuan – but we are not far off in all of those currencies too. Only in USD does gold lag – and not all of us live in the US.

Using the dollar gold price, as most of us do, has disguised what is actually quite a powerful bull market. If my memory serves me right, we saw the same phenomenon – a stealth rally in minor currencies – ahead of the last major gold bull run (in dollars) in the late 1990’s. Arguably this may be a very good leading indicator.

Faulty yardsticks also takes us onto wealth management. Measuring our net worth in local currencies, we might be rather pleased with ourselves – smug even. However we chose to ignore the fact that the yardstick is not a constant … it is shrinking and sometimes really quite fast. It’s the natural corrosive effect of inflation. Knowing this, governments give us a gauge for yardstick shrinkage to use such as RPI or CPI, to reassure you that the shrinkage is minimal… and then lie about it.

There are alternatives.

In the US, the Chapwood Index is highly regarded as it reflects the true cost-of-living increase. Plainly and simply, the Index shows that incomes can’t keep up with expenses, and it explains why people increasingly have to turn to the government for entitlements to bail them out. The basis of the Index is fullly open to scrutiny and if correct suggests Americans have been losing roughly 10% of their wealth each year since 2014. Half of it gone. This compares with the official government figure of 1.9%. Ronald Reagan called inflation “the thief in the night” and it is built for times just as this. It gives the appearance of being wealthy (maintaining high nominal values) while eroding your actual position – which manifests itself in far higher costs on the other side.

Interestingly, gold has seen an average year-on-year gain of about 10% compounded since 2000 – off-setting those real losses – which reaffirms in our mind that it continues as a reliable yardstick against which to measure costs or indeed wealth. In short, gold has maintained what economists call “purchasing power parity” for millenia. So not only is it an excellent yardstick – its actually quite a useful thing to own – especially if you fear wealth erosion. If you haven’t already read this, you must – see :Jastram’s Golden Constant

Many crises invariably start with stealth inflation and then follows currency weakness – so gold gets expensive and then it blows out significantly higher in your local currency. Then you realise that the lifeboat has sailed … the choo-choo train has left the station.

For the unprotected, your backstop plan to protect your wealth by “buying gold when I need it” has just failed. You are now trapped with a dissolving currency and every financial escape route looks too expensive … and so it goes. Ask anyone in one of those 72 countries (see below) where gold is starting to look expensive.

In short, insurance is best bought before you think you need it … boring, but true.

PUBLISHED MON, JAN 14 201911:33 AM ESTUPDATED MON, JAN 14 20193:33 PM ESTRichard X. Bove

KEY POINTS

• China and its allies have placed a great deal of emphasis on using the yuan as a dollar replacement in many parts of the world.
• In areas where this has happened, it presents a threat to U.S. trade and economic health, writes Dick Bove, analyst at Rafferty Capital.

No one is likely to dispute the fact that China and its allies are working diligently to establish a multilateral world. In it China would control its own sphere from the eastern Pacific rim to the countries located along the historic “Silk Road.” That trade route stretched from East Asia to West Africa.

In this regard, a great deal is being written about the Chinese military build-up in the Pacific; the theft of technology secrets; unfair trade policies; and discriminatory investment practices. Very little focus has been placed upon the creep of the yuan and the expansion of the Chinese banking system. Yet, this might be the greatest threat of all.

China and its allies have placed a great deal of emphasis on using the yuan as a dollar replacement in many parts of the world. In those areas where this shift has occurred countries fall out of the United States orbit. This impacts U.S. economic health and, at some point, will affect the ability of this country to grow trade internationally and to fund its debt with international resources.

Yuan Creep

Prior to China joining the World Trade Organization in December 2001, only a few hundred banks in the world would clear transactions completed in yuan. A decade later, it was reported that well over 10,000 banks, worldwide would transact in the yuan. So many global entities were using the yuan that in October 2016, the International Monetary Fund (IMF) decided to include the yuan as one of four currencies backing its Special Drawing Rights (SDRs). In sum, the yuan had become one of the world’s reserve currencies.

The yuan had reached this lofty level due to a three pronged approach. First, countries that had historic issues with United States dollar dominance supported greater use of the yuan. They include Russia, Iran, North Korea and to some extent South Africa and Brazil.

Second, China isolated countries that were having difficulty accessing large amounts of dollar based loans due to poor repayment histories. In South America this included small nations like Ecuador and larger countries like Venezuela and possibly Argentina. In Africa, the list is very long. At the top is Angola, Ethiopia, and the Republic of the Congo.

The third group of nations are countries, primarily in east Asia, who trade heavily with China. In many cases, the Chinese demand that these nations use the yuan in all trading transactions. In fact, China has gone even further. It has established the Asian Infrastructure Investment Bank, a replica of the western world’s IMF. This banks is funded by China and lends to other Asian nations.

Stated crudely, the yuan is becoming the dominant currency in many countries with small and troubled economies but the world’s largest and fastest growing populations.

Why is this Important?

The American Century was built on many factors related to the stability of this nation’s economy; its strong military; and its financial dominance. Following World War II, one might argue that the dollar was the only currency in the world that mattered. Backing this currency was a large, relatively stable, banking system. If a nation wanted to trade internationally it had to have dollars and the only place to acquire them was from American banks.

Some would argue that this financial dominance led to the creation of the multilateral rules and organizations that fostered and incentivized the global growth that developed in the past 7 decades whereby virtually every nation benefited. If yuan creep continues these rules and organizations will be re-written.

Most importantly, large areas of the world will function under a new financial system orchestrated by China. From the perspective of the United States this would reduce this nation’s trade and its ability to fund its debt. Yuan Creep has the potential to cause major disruptions in this country over time.

How is the U.S. Reacting to this Threat?

Actually, the U.S. is unwittingly aiding Yuan Creep. This country is penalizing domestic banks that increase in size. It is putting operating restrictions on American banks that operate in global markets. It is using its banks to attack other nations with a variety of financial sanctions. It is penalizing foreign banks that compete with China in nations shifting their financial allegiances.

The United States is creating a financial vacuum into which the Yuan is creeping. The biggest banks in the world are now headquartered in China. The biggest U.S. bank is smaller than the fourth biggest Chinese bank. This is simply bad for this country.