Dollar

Woes?

Sahil Mahtani: The dollar may be knocked off its pedestal

Will the U.S. dollar soon lose its status as the world's pre-eminent currency? The consensus is no—it's said that any move away from the dollar would take decades. This view is too complacent. 

The increasing use of economic sanctions under Presidents Obama and Trump is the immediate cause of dedollarization. In European finance, few have forgotten the $8.9 billion fine meted out to French bank BNP Paribas in 2014 for violating U.S. economic sanctions against Iran. It's not that surprising, or even that significant, when Russia shifts $100 billion of dollar-denominated reserves into Chinese yuan, euros and Japanese yen, as it did last year. But the change in posture among the trans-Atlantic democracies is noteworthy. At his final European State of the Union address, European Commission President Jean-Claude Juncker said: "It is absurd that European companies buy European planes in dollars instead of euros." 

Meanwhile, political polarization in the U.S. implies budget deficits as far as the eye can see, driven by tax cuts and higher entitlement spending. Congressional Budget Office forecasts show U.S. federal debt hitting 152% of gross domestic product by 2048, up from 78% today. The U.S. twin deficits -- fiscal and current account -- are a good leading indicator, with a two-year lag, of dollar weakness. They currently imply double-digit percentage declines in the dollar's value over the next few years. 

Significant currency shifts are rarely long and slow affairs. Britain's pound sterling was in a gentle postcolonial stupor until the early 1970s, when it still accounted for just under a third of global sovereign reserves. By the end of that turbulent decade, it was less than 1/20th. In the 1930s countries off the gold standard, such as the U.K. and Italy, saw currency declines of 20% to 40% in three to five years. Even the dollar lost nearly half its value against the deutsche mark from 1971-78. Foreign currency became so expensive that U.S. soldiers stationed in Germany at the end of the decade received care packages from sympathetic West Germans.

DYI:  This blogger was stationed in Germany with the U.S. Army during that exact period of time and went through the dollar devaluation against the Deutsche Mark and Swiss Franc.  However even though I was in my early twenties I had read Harry Browne’s book You Can Profit from a Monetary Crises and his Guide to Swiss banks.  So I opened a savings account with Bank Leu of Switzerland converting as many dollars as I could save [I was an E-4 living in the barracks] and lo and behold when the dollar bottomed out I converted back into dollars with a simple interest return (based on conversion) of 25% per year.  How did I know it had bottomed??  On my little base in Erlansee Germany the post bank [run by American Express] day after day there were long lines all converting to Deutsche Marks.  I knew right then and there this was madness of crowds – before I even read the book by Charles McKay – they were all wrong.  At an early age I had a contrarian bent it has served me well. 

Some will say that we've heard this all before. Persistent talk of a shift away from the dollar began in the 1970s, and recalls historian A.J.P. Taylor's assessment of the revolutions of 1848: "a turning point that did not turn." Habitual dollar use remains high—everywhere. Nevertheless, the emergence of a genuinely multipolar world means the coming market cycle is likely to be different. The U.S. dollar may finally be knocked off its pedestal.

DYI:  This is a definite possibility.  When a loss of confidence sets in just as what happened to the dollar during the 1970’s a multi-year crash is in store.  Here at home it would be seen as high inflation as most folks would not know of the crashing dollar.  And yes inflation during the 70’s was just a bad as you have heard only tamed by Chairman Volker of the Fed with his ultrahigh interest rate policy to break the back of inflation.  And by the way set up the bond buying opportunity [and utility stocks] of a lifetime.

So far I’m in the camp of a slow grinding affair of the American dollar despite all of its problems our currency is the best looking horse in the glue factory.  However, there is no doubt; countries such as Russia and China are working at feverish pace to move away from the dollar with their respective trading platforms for Rubles and Yuan plus gold.  Despite Russia’s large land mass their GDP measured in dollars [1.578 Trillion] is less than England [2.622 Trillion].  In the big picture Russia pulling away is not that much of an event.  China despite their trading platform with Russia and the surrounding countries will continue to use U.S. dollars in some form only due to their exports to America.      

 

DYI