Dollar Redux
“Gold is money, everything else is credit”
J P Morgan
Putting aside the human tragedy resulting from the Second World War, the one major “takeaway” from that conflict was the staggering economic and military might, possessed by the USA. Factors which allowed it to successfully conduct a global war on two fronts whilst at the same time winning the race to become the first global nuclear superpower. Since then, the USA has been the undisputed global hegemon – a position which, as a result of the Bretton Woods Conference in 1944, has also meant that the US$ has been the unequivocal global reserve currency to this day. The original iteration of the Bretton Woods conference saw the US$ pegged to Gold at a rate of $35 per 1 Oz of Gold, meaning investors could have full faith in the currency as a store of value
However, with President Nixon taking the US$ off the Gold Standard in 1971, it effectively became a fiat currency backed by nothing more than the “full faith and credit” of the US Government.
21 November 2022
Things might have worked out somewhat differently for the US if they had not, quite wisely, persuaded the Saudis to agree that all trade in Oil was henceforth only be traded in US Dollars. In return the US agreed to provide military and other industrial support to the Kingdom. This meant that the US$ effectively became a Petro-currency and that arrangement has served the USA extremely well over the last 50 years and helped entrench the US$ in the role of the global reserve currency – an advantage which the French once referred to as “an exorbitant privilege”.
That situation remains essentially true to this day, and the vast majority of global trade is still conducted by reference to the US$. However, breaking the peg with Gold allowed the US to follow less prudent monetary and fiscal policies than might otherwise have been the case. The temptation to “print & spend” might just be considered acceptable if the policy was conducted in a cautious manner. Regrettably, over the last 50 years, the word cautious could in no way be applied to the monetary or fiscal policies of most major economies. Quite the reverse in fact.
Early into this “fiat experiment” the authorities showed a modicum of restraint as Debt, GDP and Stock Market values grew roughly in line, (as might reasonably be expected). But once US interest rates peaked in the early ‘80’s (at close to 19%) and then started to move lower, so Debt and Equity Market valuation levels started to rise faster than GDP, gradually at first but then more rapidly. The brakes were really released from the mid 90’s helping to initially fuel the Dot Com bubble, and since then both the Sub-Prime bubble and the latest “bubble in everything” – which we are now seeing unwind.
From January 1972 to January 2000 US GDP rose by approximately 150%, or by 3.3% annualised, whereas over the same period, freed from any sense of monetary restraint or responsibility, total US Debt rose by around 1,100% or close to 10% annualised and the Dow rose by around 1,160%, or 9.49% annualised… strongly outstripping GDP growth.
In a healthy economy one would reasonably expect the performance of Debt and Equity markets to be somewhat closely correlated to GDP growth. Any strong outperformance of debt and/or equity markets, in excess of GDP, would strongly suggest that the realised growth in GDP had been largely reliant on taking growth from the future, and that is exactly the situation the US now finds itself in.
To compound the problem, demographics do not play well in terms of addressing these imbalances, nor do the very extremely high levels of debt now burdening US society. And let’s not forget the debt, exorbitant as it is, does not reflect unfunded liabilities, which are calculated to be close to the same size as those reflected, namely around $31 Trillion US dollars….and rising.
So called “light touch” regulation enacted by many western governments, added to the extreme monetary measures taken by central banks in 2000 and 2001, to help fight the deflationary surge resulting from the Dot Com bust directly helped fuel the next bubble in subprime property which blew up so spectacularly in 2008, creating an existential threat to the global financial system. For some inexplicable reason central banks, presumably recognising that too much debt had almost done for the global financial system between 2001 and 2008, decided that more debt was what was actually needed to cure the previous problem(s) created by… you’ve guessed it… too much debt. The difference post-Global Financial Crisis (GFC) is that risk was moved off bank balance sheets and effectively moved on to the balance sheets of pensioners and other savers, who are now the ones seeing their pensions depleted by the fall in equity and bond prices this year.
If asked to choose between Covid or the War in Ukraine as to which of those two will have the greatest long-term impact on the global economy in the years ahead, I think most people would (understandably) say Covid. Whilst the pandemic did cause people to reassess many things, including the vulnerability presented by “just in time” supply lines, we believe that the War in Ukraine will ultimately prove to be the biggest driver of global change.
Whilst many of these issues were rumbling under the surface prior to the outbreak of hostilities, the West’s policy response, in particular that of the USA, has led to a clear polarisation between the major global protagonists with China & Russia leading one camp and the US/Europe leading the other. The seizure / freezing of Russian assets by the West has brought into much clearer perspective the real risks involved in holding assets denominated in US Dollars (and to a lesser extent the Euro and GBP).
These moves have made / will make ALL investors examine much more closely the risks associated with holding assets in US$ and most particularly as relates to FX reserves. By weaponizing the US$, the US has sent a very clear message: “if you have assets in US$ and they are within the global financial system, and you do something we don’t like, we will not hesitate to freeze those assets”.
The US now has to tread reasonably carefully, given that it still needs foreign investors to keep financing its very considerable deficits. As mentioned, this is something that has been of concern to both China and Russia for some time now and it is the main reason why they have both been looking to move reserves out of US Treasuries increasingly into Gold. In addition, they have been working on agreeing to settle Oil and other commodity purchases in Yuan, and in fact at the 14th BRICS Summit held in October: Russia, China, India, Brazil, and South Africa agreed to examine the establishment of a new “global reserve currency” with which to finance trade between themselves. Other countries like Turkey, Saudi Arabia and Argentina have since expressed an interest in joining. Weaponizing the US$ does come with risks for the USA. Countries with pegs that hold assets in US$ can’t be that comfortable that if they cross the USA their assets might get frozen.
About 66 countries have their currencies pegged to the US$ with a half dozen others having floating pegs. Some of the major economies with pegs to the US$ are Saudi Arabia, the UAE, Qatar and Hong Kong. Already there is anecdotal evidence that some of these countries are drafting contingency plans to “de-dollarize” if risks increase.
The USA now faces a clear and present danger as regards the continued willingness of foreign investors to finance the US deficits if they feel the threat of seizure is real and / or they feel that higher US indebtedness is likely to lead to more debasement of the US$ over time.
But what if the US could reassure investors that not only are those risks low but that actually exposure to the US$ could go hand-in-hand with exposure to an alternative asset class? One where underlying investments perform a number of functions which are increasingly important to the modern generation? Namely: security, confidentiality and trust, and where assets sit outside the usual constraints of Traditional Finance (Trad-Fi) but rather sit “off grid” as part of the decentralised Finance (De-Fi) network with lower frictional transactional costs.
Source: Bitcoin Magazine
Technology – Adapt or Die
Since its introduction in 2009, Bitcoin has traded by reference to the US$ and this puts the US$ in a very strong competitive advantage versus other fiat currencies given the very powerful network effect established over the last 13 years. Despite (in fact precisely because of) many of the high profile “busts” seen in “cryptoland” recently, more and more stablecoins are beginning to be fully backed by US denominated government debt, as this provides the investor with the security that their assets cannot be unilaterally seized by a fiat issuing government (because “off grid”) whilst at the same time being backed by very high value collateral.
The simple question most investors ask (or should ask) when making FX decisions should be “who do I trust the most?” All fiat currencies devalue over time, so which currency you want depends on which you most trust to function as an effective: medium of exchange, unit of account, and store of VALUE.
In the 70’s, having come off the Gold standard and suffering from high inflation, the US had to find something to “peg” the currency to in order to restore trust and confidence in the currency. Turning the US$ into a de facto petro-currency did the trick. Today, the US faces similar issues. Inflation is high and so are US debts. How can the US best persuade investors to keep faith in the US$?
Gold has been a favourite store of value for many years precisely because it was no-one else’s liability. Investors took (take) no counterparty risk. It can’t be created out of thin air. It is universally trusted. But it is not digital.
Bitcoin was designed to be digital gold. There will only ever be 21 million bits issued. It is not anyone’s liability, and it sits on a blockchain precisely because the creator wanted it outside the traditional financial system so that people could trust the integrity of the coins.
As the saying goes: “for thousands of years money has been backed by gold and trust and been protected by ships. In this millennium money will be backed by encryption and maths and protected by chips”.
The US Government already owns 1% of total Bitcoin supply which amounts to 214,000 Bitcoin worth about $3.5 billion based on a price $16,500 for XBT.
It is not beyond the realms of possibility that, as a means of ensuring that the US$ retains its reserve currency status and ensuring rival bids to set up a new “reserve currency” are nipped in the bud, that the U.S Treasury / SEC look to embrace crypto / digital currencies more wholeheartedly. How? By increasing the level of regulation in such a way that faith in “Crypto” generally increases without becoming too burdensome, allowing investors to become more comfortable with digital currencies becoming mainstream investments.
The recent collapse of some high-profile crypto exchanges and coins is actually a very healthy development for this new asset class, very similar to the “incineration” seen during the Dot Com crash where about 90% of Dot Com businesses eventually went bust. This cleansed the system, leaving the field open to the true Dot Com winners able to make the most of the development of the internet and mobile telephony. Much the same is likely to happen now within digital currencies, with those that survive likely to prove the long-term winners.
For the US$ to become a “petro-currency”, the US did not need every Dollar issued to be backed by Oil. All it meant was that if you wanted to trade Oil you needed US$ to price and settle the trades. Similarly, if the US actively embraces Crypto as a global asset class, then investors will need US$ to price and settle trades, and the US$ will become the fiat currency through which digital assets grow and gradually become part of the mainstream investment arena.
They say that money makes the world go round and we can’t see that changing any time soon, but, as with most things, money needs to adapt and evolve in order to perform its primary function most effectively. In my lifetime we have gone from a cash dependant society to one where it is almost cashless. We have gone from transferring money by writing cheques to transferring money via banking apps on our mobile phones.
The currency which serves as global reserve currency will have to embrace the digital revolution now taking place. The US$ is in pole position to ensure it monopolises on this opportunity. The question is, will the Government and its Agencies recognise the opportunity and act accordingly?
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