Is The Us Dollar As A Reserve
Currency Losing Steam?
Rise and fall of Reserve Currencies:
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- From 1450 to 1530 (80 years) - Portugal had the best Naval fleet and navigation skills and could colonise parts of Africa and Asia and developed trade routes.
- From 1530 to 1640 (110 years) - Spain, along with Portugal, created the Iberian union - also with the dominance of world trade routes.
- 1640 to 1720 (80 years) - Dutch due to the efficient Dutch East India Company and for their trade routes - growing demand for spices at that time.
- 1720 to 1815 (95 years) – France, due to the French East India Trade Company - continuing with the trade dominance.
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- 1815 - 1920 - (105 years) – Britain, due to the early
adoption of the Industrial Revolution and having
control over 1/5th of the World population and owned
1/4th of the land and with it the resources.
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Rise of Dollar as a Reserve
Currency (1920 to ?)
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- Growing industrial oil bases with Rockfellow, Henry Ford with the Assembly line, Vanderbilt for banking and finance.
- The US entered both World Wars first as War merchants and later as War participants, and dominated land, air and sea. Other European countries were trying to rebuild at the end of the War and had crippling debt. The US economy, on the other hand, grew in this period. At the end of the war, the US had 75% of the World’s Monetary Gold - 22000 tons.
- Bretton Wood's agreement in 1944, where over 41 countries agreed to peg their currency to the dollar and the US dollar was pegged to gold (1 ounce of gold = 35 dollars). Creation of the World Bank and IMF by the US - where loans were given in Dollars.
- US Dollar and Oil - In 1938, a US company found vast oil reserves in Saudi Arabia, which then was a poor nation. The US promised the security of Saudi Arabia in 1945, with the commitment that oil would be sold only in dollars. After the 1960s, all oil in the Middle East was sold in dollars - PetroDollars.
- After the expensive Vietnam war, and with the US increasing its debt, many countries felt the value of the dollar was decreasing and started converting dollars into gold. 22000 tons of gold in the US after WW2 had fallen to just 10000 tons. The US could not meet its obligation of converting all the dollars in circulation to gold. So in 1971, President Nixon removed the
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- convertibility of dollars to gold and stated that the strength of the Nation's currency depends on the strength of the Nation's economy. The most valuable commodity moved from Gold to Oil - PetroDollars.
- SWIFT network developed by the US - 6 entities
- Local Seller Trader
- Local Seller Bank
- American Bank 1 of Seller in the US
- American Bank 2 in Buyer in the US
- Local Buyer Bank
- Local Buyer Trader
- US 7 trillion is held in reserves for different countries in dollars in Sept 2021. The countries held their excess dollar in US Government gilts, which allowed the US to have a ready market for their unlimited printing of dollars and increase in debt.
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- Both the Swift and the Dollar reserves have been weaponised from time to time by the US, which has worried China and Russia. They have joined hands to take down the mighty dollar.
- Russia is one of the largest Oil and Gas producers in the World, apart from the other minerals they hold. They forced the other countries to buy their oil in Ruble, bypassing the Dollar Reserves. They have been preparing to reduce their dollar dependence since 2014 and have cut their dollar reserves from 150 bn in 2014 to 3.9 bn in 2021.
- China started its Belt and Road initiative - a 3-tn dollar initiative. They have given soft loans to 165 countries - some of these countries cannot pay back, which we have seen with both Pakistan and Sri Lanka. They have incentivised them to pay back in Yuan. In 2018 Pakistan had already agreed to pay for their bilateral trade in Yuan. China has become the largest trading partner with 25 Belt & Road countries However most of these countries are poor countries
- Many countries, including India, have started a Bilateral trade swap. They decide on the amount of trade and the exchange rate for a fixed number of years. Earlier they would have to go through 6 partners, including the dollar banks of both countries, which takes time and money. Now the US dollar bank is being cut out. China has signed more than 3-tn yuan worth of Bilateral currency swaps with more than 40 countries, including South Korea, the UK, Singapore and Russia. With 20% of the world's manufacturing coming from China, they could further use this to push for payment in Yuan.
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Challenges for Yuan
- The notorious reputation of both China and Russia.
- China has been devaluing its currency frequently.
- China is not so transparent.
- BRICS countries (of which India is one) aim to de-dollarize the Global Financial System. They account for 40% of the world population, 25% of GDP and 20% of trade. Saudi Arabia and some other countries are looking to join the BRICS. They are working on a basket of commodities backed by gold. Russia is officially the 5th largest gold holder. China is being secretive about the amount of gold they hold and have not updated its data, In 2007, China overtook South Africa as the world's largest gold producer, and hence is likely to hold even more gold than the US.
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- Commodities are priced in terms of Dollars and have shown colossal volatility recently. However, it is only in terms of the Dollar - Fiat currency (not backed by any commodity/gold) -, but in terms of gold, these commodities are remarkably stable.
- US debt moved from US $ 9 tn in 2009 to US $ 31 tn. When interest rates were close to 0%, it was no issue. However, now that it has already risen to 4%, and there is a possibility to go higher, the US would have difficulty meeting its interest obligations and may have to print more money for this, or the unthinkable would happen, and the US defaults.
- If all the Dollars held in other countries come back to the US, it will cause massive hyperinflation. The interest rate will rise, and stocks, bonds and real estate will collapse. Countries have to sell their dollars to defend their currency. India's dollar reserves have gone down from an all-time high in October 2021 of USS 645 bn to US$ 524 bn currently.
However, this will not happen overnight - it will likely take years for an alternative to the dollar to be developed. In the meantime, many weaker countries, which hold their debt in dollars, will go bankrupt, like Sri Lanka, Turkey, Lebanon, Suriname, Zambia, Argentina, Ecuador, Egypt, etc. This is why the Dollar Index has been rising. Comparatively, the US is in better condition than the other countries' currencies like the Pound, Euro and Yen. However, according to Alistair Macleod, fiat currency will end in 2/3 years. At this stage, many economists are predicting the end of the Dollar as we know it - but it is unclear what will take its place.
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There is no negative signal in the equity markets. The US equity market is pulling back from its lows. The dollar index has stopped rising, which is positive for emerging markets. Overall, the Corporate results declared so far have been in line with expectations. So we see the equity market range bound with a positive bias. However, the fall in the protection of shorts is a bit of a worry.
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After a challenging year in the debt market, it is now beginning to look attractive again. The 10 Year G Sec is over 7.4%, and further upside is likely to be limited. Debt mutual funds are tax efficient if held for more than 3 years.
- Target Maturity fund - They work like a Fixed Maturity fund, where the returns at the end of the term is known, with the added advantage of liquidity in between the term.
- Constant Maturity Gilt funds have the safety and a likely to give higher returns if the interest rate cycle turns again in the next 3 years.
- Dynamic bond funds where the fund manager will change the duration of the fund, depending on where we are in the interest rate cycle.
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With the uncertainty around the world with the war, high
inflation, and devaluation of currencies, it is essential that
some real money like gold and silver be held. There is a
higher margin of safety in silver currently. Once they break
out, we are likely to see a massive rise in these metals.
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