Many Threats to U.S. Dollar as World’s Reserve Currency

by the Curmudgeon with Victor Sperandeo




Have you ever wondered why the U.S. dollar has not collapsed, considering our never ending trade deficits, massive and increasing national debt, lack of anything resembling a fiscal policy due to the gridlock in Washington?  Due to its position as the world's reserve currency, the greenback has held its own.   The US $ Index hit a low of 71.5 in April 2008, but has recently traded in a very narrow range of 79 to 81.  It stubbornly refuses to break intermediate support of 79 on a closing basis.


The U.S. dollar became the world's reserve currency in the mid 1940's due to the British debt burden causing it to have to borrow $31.4 billion from the U.S. in 19411 and approximately $3.7 billion in 1945.  OPEC oil has been priced in dollars since 1971 (see Victor's comments below for more on this topic).


Note 1.   The Lend Lease Act passed on March 11, 1941, set up a system that would allow the United States to lend or lease war supplies to any nation deemed "vital to the defense of the United States."


Today, more than half of global cross-border loans and deposits are transacted in dollars and in the last global survey of the $5tn a day foreign exchange market, the dollar was on one side of 87% of all trades.  Despite efforts to diversify, many central banks say that they still see no real alternative to the safety and liquidity of the U.S. Treasury market, and hold more than 60% of their reserves in dollars.


Events in the last week indicate that change may be in the works for the U.S. dollar in the near future.  Let's examine the weight of the evidence followed by Victor's cogent comments with the usual history lessons.


French Finance Minister Calls for End of US Dollar Hegemony:


In an interview with the Financial Times (on line subscription required) last week, French Finance Minister Michel Sapin  called for a “rebalancing” of the currencies used for global payments, saying the BNP Paribas case should “make us realize the necessity of using a variety of currencies.”


“We [Europeans] are selling to ourselves in dollars, for instance when we sell planes. Is that necessary? I don’t think so. I think a rebalancing is possible and necessary, not just regarding the euro but also for the big currencies of the emerging countries, which account for more and more of global trade.”

“Companies like ours are in a bind because we sell a lot in dollars but we do not always want to deal with all the US rules and regulations,” said a CEO of an unnamed CAC 40 company to the FT.


As noted above, dollars dominate oil and gas pricing, another cycle France hopes to break.  [The US and OPEC countries have traded oil exclusively in US dollars since 1971.]  Christophe de Margerie, the CEO of Total, France’s largest company, says "other currencies" could be used in oil purchases, even if the benchmark is left in dollars.  “The price of a barrel of oil is quoted in dollars,” de Margerie said. “A refinery can take that price and using the euro-dollar exchange rates on any given day, agree to make the payment in euro.”


A YouTube video titled “France Calls for the END of U.S. Dollar Reserve Currency! offers one pundit's view of an imminent dollar collapse.


Increased Use of Chinese Yuan for Global Trading:


More U.S. businesses are using China's Yuan (AKA renminbi or RNB) to settle commercial transactions, according to Reuters.  The Wall Street Journal    corroborates that by noting that American companies are conducting a record amount of business in Chinese Yuan, looking to benefit from cost advantages over dollar transactions.  


Payments made in Yuan by U.S. companies ranging from Ford Motor Co. to small clothing importers quadrupled over the past year to a record 2.6% of the global Yuan total, according to the Society for Worldwide Interbank Financial Telecommunication, a financial-services firm that monitors international currency flows.


The Yuan is making inroads with U.S. firms now because it is becoming more cost-efficient to pay in the Chinese currency. American importers can often negotiate better prices with Chinese suppliers if they agree to use Yuan to make a purchase. Chinese companies tend to increase prices when they settle trades in dollars as a way to offset potential exchange-rate fluctuations.  Even more U.S. companies plan to use the Yuan amid expectations by business leaders that their trade with China will increase in the next 12 months.


The U.S. recently passed Taiwan to become the fourth-largest hub for trade in the Yuan outside mainland China, after Hong Kong, Singapore and the U.K., according to SWIFT2.


Note 2.   SWIFT is the Society for Worldwide Interbank Financial Telecommunication, a member-owned cooperative through which the financial world conducts its business operations.


"More and more of our payments will migrate to the renminbi now that it's easier to do so," said Ryan Hershberger, Ford's treasurer of Asia-Pacific in Shanghai. "We think the benefits will accrue over time."


17% of U.S. businesses leaders said their companies had used RMB to settle trade this year, up from nine percent last year, according to an HSBC global survey of international business decision makers in 11 countries, including 102 in the U.S. The global average was 22%.  This places U.S. businesses just behind French (26%) and German (23%) businesses in terms of RMB use outside of China, Hong Kong and Taiwan.


Cities around the world are racing to establish trading centers for the Yuan, which HSBC said in March surpassed the euro last year to become the most widely used currency in trade finance after the U.S. dollar. China has already signed agreements to trade the Yuan more freely with Singapore, London, Frankfurt and others as part of an economic restructuring that includes taking steps to loosen exchange controls.


In a past Curmudgeon post: China’s Yuan as World’s Reserve Currency, Victor wrote: "China is accumulating Gold (i.e. real wealth) and thereby accumulating the power to back their currency.  That means I'd bet on China's Yuan/Remnibi at the moment vs the U.S. dollar."  


For some time, Russia has been actively working to de-dollarize, and is starting to use the Yuan and other Asian currencies in trading.  Russia will start settling more contracts in Asian currencies, especially the Yuan, in order to lessen its dependence on the dollar market, and because of Western-led sanctions that could freeze funds at any moment.


“Over the last few weeks there has been a significant interest in the market from large Russian corporations to start using various products in renminbi and other Asian currencies, and to set up accounts in Asian locations,” Pavel Teplukhin, head of Deutsche Bank in Russia, told the Financial Times.


ShadowStats Continues to Forecast a Sharply Declining Dollar:


In a July 11th note to subscribers, ShadowStats John Williams said: "The Outlook Continues for Massive U.S. Dollar Sell-Off."  Williams believes that second quarter U.S. GDP will be negative- if not in the initial report, then on a subsequent revision.  Financial-market expectations will thereby shift towards a U.S. recession with rising U.S. budget deficits and mammoth funding needs of the U.S. Treasury.  That negative economic growth scenario, combined with fundamental factors, will place "mounting and massive selling pressures on the U.S. dollar,” according to Williams who opines that the fundamental issues threatening the dollar "could not be worse." 


"Fed Has Monetized 76% of Net Issuance of Publicly Held Treasury Debt, Since January 2013 Expansion of QE3; Pace of Fed Monetization at 88% Year-to-Date 2014."


Victor's Comments:


After Nixon took the U.S. dollar off the gold standard 1971, oil priced in gold backed U.S. dollars became oil priced in "fiat dollars."   If OPEC ever decides to price its oil based on a basket of currencies and gold or silver, the U.S. dollar would end its kingpin status.  But Saudi Arabia believes it has the US military at its disposal for "protection" and thereby the exchange of oil priced in dollars is maintained by OPEC.


The perceived confidence and "power" of the U.S. (which is diminishing every day) enables the dollar to continue to be the world's reserve currency.   In addition, there is massive dollar manipulation by the Fed which has prevented it from breaking down on foreign exchange markets.  How long can that continue?


Going forward, the fiscal situation in the U.S. is dire.  Off balance sheet and unfunded liabilities are truly impossible to repay along with the stated U.S. national debt of $17.6 trillion (As of July 2, 2014). 


Both Obama's latest budget and the CBO forecast the gross debt to be $27.5 trillion in 2024 - up from the current $17.6 trillion - almost a $10 trillion increase!


What will the average interest rate be in 2024?  For the last 53 years it was 6.1% using T-Bill yields + 30 year bond yields divided by two (Source:  Ibbotson Associates year book).   That rate implies the U.S. will pay interest on debt of $1.7 trillion on revenue of $4,936 trillion in 2024 (Source: CBO).  In other words, 34% of the all the revenue will go to debt service!  Today the U.S. pays 6% of all revenue to service the national debt.


The U.S. debt situation could be a lot worse.  A real possibility is that if debt grows at its historic 36 year annual rate of 9.1% (which would come from at least one recession) the stated debt in 10 years would be  $42 trillion with interest of $2.6  trillion or 52.7% of all estimated revenue in 2024!  Do you think that's sustainable? What would the U.S. government and the Fed do in that case?


The only way to repay the U.S. debt is to inflate it away.  It seems the national debt always increases, while stated inflation rate is subdued.  That's in large part due to the BLS changing the way it calculates the CPI (to in effect "defraud" the seniors they promised to pay via indexing their social security payments using an understated inflation rate).    


In my view, everything is manipulated, little seems true or accurate, and it only gets worse.  It seems no officials are accountable for their actions and the federal government gets away with all it wants - see the recent IRS scandal (Lois Lerner, et al) for one example.  The interests in controlling the system are huge and the ability to change this seems to be impossible on its own - until a collapse comes.  


Why isn't all of the above exposed and well known? It's because the mainstream press is strongly progressive and rarely reports the reality of these dire truths to the public.  For example, the fact that the "Federal Reserve" is a privately owned cartel whose owners are secret is not reported.  


What about government watchdog agencies like the Congressional Budget Office (CBO)?  The CBO "provides the Congress with assessments of the economic impact of the Federal budget... analyses of alternative fiscal, budgetary and programmatic policy issues.  Are they being honest in their analysis and assessments? 


The CBO Feb 2014 report "The Budget and Economic Outlook 2014-2024“ doesn’t seem realistic in my view.  In that report, the CBO is predicting NO recessions for the next 10 years.  GDP growth of 3.1% is forecast for this fiscal year ending September 30th.  The CBO also forecasts 3.4% GDP growth in 2015 and 2016 and 2.7% in 2017.   Considering the very sluggish post-recovery economy (which continues to disappoint), how can anyone believe those CBO predictions?


The timing of a massive dollar sell off is a psychological call.  The timing is uncertain, but it will happen.  At some point in time, dollar holders will lose confidence in the greenback and - like a run on a bank - it will suddenly crash.  


Consider the following scenario: If we enter another recession, which leads to a debt explosion, dollar holders will start selling the dollar and the debt it represents. That might prompt the Fed to buy dollars and U.S. debt which would cause hyperinflation the world rarely sees.


Would the foreign exchange market accept the Fed printing dollars to pay interest to U.S. debt holders?  I don't think so!  Nowhere in history does it show that debt holders accept the printing of money to pay principal and interest.  Once you are in this position - to use the words of "Il Duce" (Benito Mussolini) which served as his own epitaph: "Non si torna indietro" (There is no turning back).


Till next time........................


The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

Copyright © 2014 by The Curmudgeon and Marc Sexton. All rights reserved.

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