The idea that the dollar’s dominance of global finance could end was just a marginal view five years ago, when America’s net foreign investment position was just negative $ 8 trillion. Reading forecasts for the end of the dollar era are now being read in research reports by Goldman Sachs and Credit Suisse. The seizure of Russian foreign exchange reserves by Washington seems like a self-destructive measure given America’s enormous and accelerating dependence on foreign borrowing. Surprisingly, America’s strength lies in its weakness: a sudden end to the dollar’s leading role in world finances would have catastrophic consequences for the US economy, as well as the economies of its trading partners. In addition to the $ 18 trillion net foreign investment in the US, foreigners hold about $ 16 trillion in overseas deposits to finance international trade. That’s $ 34 trillion in foreign funding, compared to $ 23 trillion in US GDP. Foreigners also have huge exposure to the US stock and real estate markets. Nobody – at least China with its $ 3 trillion reserves – wants a move against the dollar and the dollar’s assets. But the world’s central banks are reducing their exposure to dollars, cautiously but steadily. The drop of differentiation from dollars could turn into a flood. What the International Monetary Fund called March 22 “the hidden erosion of dollar dominance” presupposes a not-so-secret exit from the dollar. Unlike Nebuchadnezzar’s manuscript on the wall, the king’s fortune tellers can read the message as clearly as day. In particular, the Central Bank of Russia reduced the share of the US dollar in its reserves from 21% a year ago to just 11% in January, while increasing the share of the RMB to 17% from 13% a year ago. Russia’s central bank has also bought more gold than any other institution in recent years. With just 8% of world export volume versus 15% of China, the US dollar’s reserve role no longer reflects America’s economic strength. It comes, wrongly, from the rest of the world’s desire to save. The populations of the world’s high-income countries are aging rapidly. In 2001, 28% of their people were aged 50 and over. by 2040 the percentage will reach 45%. Aging populations save for retirement. The Germans and the Japanese save almost 30% of GDP and the Chinese save 44%. Americans save only 18% of GDP. For the past 15 years, American consumers have been spending about $ 1 trillion more on goods each year than US imports. The boom in imports due to imports and the availability of cheap electronics from China and other Asian exporters fueled a boom in digital entertainment that pushed up shares of Apple, Microsoft, Google, Meta and other US software companies. Foreigners then invested their export earnings in U.S. tech stocks, as well as government bonds, real estate, and so on. The technological boom has hurt the US economy far more than it has helped, reducing American teens to the deterrent risk of being addicted to smartphones and social media while creating stock market valuations we never imagined. The result is the biggest bubble in world economic history. When the Covid-19 pandemic threatened to collapse the bubble, the US government added $ 6 trillion in stimulus to the economy. This restarted the technology bubble, which explains why the US net foreign investment position fell by another $ 6 trillion between 2019 and 2022, to the current negative level of $ 18 trillion. The bubble is so huge that the whole world has a share in it and none of the world’s great economies can detach from it without significant damage. China suffers from punitive US tariffs and sanctions on technology imports, sending more than $ 600 billion worth of industrial products to the US each year – nearly a third more than before the Trump administration imposed tariffs in 2019. Leaders of China want to encourage more consumption and less savings but can not convince the Chinese to consume. China, therefore, continues to export to the US and save revenue. People can do very well without the dollar to finance trade. India and Russia can settle transactions in their own currencies, with their respective central banks providing rupees and rubles as required through exchange lines. Russia’s surplus with India will be invested in India’s corporate bond market, according to news reports. India is reportedly preparing to increase exports to Russia by $ 2 billion a year, a 50% increase from current levels. China, meanwhile, is paying for oil imports from both Russia and Saudi Arabia in its own currency. The RMB has appreciated against the US dollar by more than 12% since September 2019 and continues to offer higher real returns than the dollar, as well as a number of investment opportunities, despite China’s exchange rate controls. Nothing is stopping 76% of the world’s population whose governments have refused to join Russia in financing local currency trade. Asian countries now have $ 380 billion in swap lines, more than enough to serve the entire Asian trade. To the extent that long-term trade imbalances arise, central banks can be established by transferring gold. Several misleading media reports have suggested that the US could prevent Russia from using its gold reserves. This is inaccurate. The US can keep Russia away from public gold markets, but it cannot stop Russia from trading gold with the central banks of India or China. It is no coincidence that the same central banks that bypass the dollar financing system have bought the most gold in the last 20 years, according to the World Gold Council. CountryGold Purchases since 2002 (tonnes) Russian Federation1876China, PR: Mainland1448Turkey562India400Kazakhstan, Rep. of323Saudi Arabia180 China and Russia were the largest buyers of gold, followed by Turkey, India and Kazakhstan. The value of gold relative to competing US dollar assets is at an all-time high. Under normal circumstances, investors receive the same kind of protection from US government bonds with an inflation index – Securities from Government Inflation (TIPS) – as from gold. In the event of a sudden fall in the value of the dollar and a corresponding rise in the US price level, TIPS will pay a bonus to investors depending on the rise of the US Consumer Price Index (CPI). Over the last 15 years, the co-movement of gold and TIPS returns has been a remarkably high 85%. But TIPS and gold differed in three cases. The first was Lehman’s bankruptcy in 2008, which hit the global financial crisis. The second was the near-bankruptcy of Italy in 2011. And the third, and more extreme, occurred in the aftermath of the war in Ukraine. At about $ 1,970 an ounce, gold is now a “fortune” of $ 437 in TIPS, as the chart above shows. The sharp rise in US yields over the past two months would have pushed gold prices below normal. However, the seizure of central bank assets by executive authorities is far from normal. Gold trades just around the all-time high despite rising interest rates. Another way to view the same data is in the form of a gold spread chart versus the 5 year TIPS yield. The current price of gold, as noted, is $ 437 above the regression line. One reads about the falling dollar in the newsletters of currency traders and monetary cranks. But now the most conventional of all commentators, Goldman Sachs’s research division, warns that the dollar will follow the path of the British pound. Economists Cristina Tessari and Zach Pandl wrote on March 30: The dollar today faces many of the same challenges as the British pound in the early 20th century: a small share of world trade relative to the dominance of the currency in international payments, a deterioration in net foreign assets and potentially adverse geopolitical developments. At the same time, there are significant differences – particularly less severe domestic economic conditions in the United States today than in the United Kingdom after World War II. If foreign investors became more reluctant to hold US liabilities – [for example] due to structural changes in world commodity trade – the result could be a devaluation of the dollar and / or higher real interest rates in order to prevent or slow down the devaluation of the dollar. Alternatively, US policymakers could take other steps to stabilize net external liabilities, including tightening fiscal policy. The bottom line is that whether the dollar retains its dominant reserve currency status depends, first and foremost, on US policy. Policies that allow the maintenance of non-volatile current account deficits, leading to large external debt accumulation and / or high US inflation, could help to replace other reserve currencies. Credit Suisse analyst Zoltan Posznar wrote on March 7: We are witnessing the birth of Bretton Woods III – a new world (monetary) order focusing on commodity-based currencies in the East, which is likely to weaken the Euro-dollar system and also contribute to inflation in the West. A crisis is unfolding. A commodity crisis. Commodities are collateral, and collateral is money, and this crisis concerns the growing charm of foreign money over domestic money. The Bretton Woods II was built on domestic money and its foundations collapsed a week ago when the G7 took over the Russian FX reserve. What should investors do in this environment? One recalls the old joke of the Brezhnev era about the recommended procedure in case of nuclear war: “Put on a white sheet and walk to …
