Shifting tectonic plates

The steadily moving global financial tectonic plates have accelerated in recent months, spurred on by the global pandemic and technological advances. At the epicentre of their drift is the US Dollar, the world’s reserve currency. Like melting glaciers, this process is not going into reverse.

The latest blow to the dominance of the US Dollar as the global reserve currency comes from Russia.

On 3rd June, the Russian sovereign wealth fund, its “National Wealth Fund” (NWF), said it would ditch all its US Dollar assets and increase its holdings in Euros, Chinese Yuan, and — for the first time — gold. Some analysts have said this implies ridding itself of $40 billion in favour of Euros, Yuan and gold. The allocation to gold would be 20%, said the NWF.

As of June 2020, the Russian central bank’s international reserves held 23% in gold. For the first time in recorded history, gold then nudged above the bank’s US Dollar assets (which stood at 22%). Russia has spent more than $40 billion building its gold reserves over the past five years, making it the world’s biggest buyer. The central bank said it stopped buying gold in the first half of 2020 to encourage miners and banks to export more and bring in foreign currency into Russia after oil prices — on which the Russian economy depends — crashed.

As of 1 May, the NWF had the equivalent of $185.9 billion in assets; it forms part of Russia’s gold and foreign exchange reserves, which stand at the equivalent of some $600 billion.

If the NWF needs to spend $40 billion on its ‘new’ assets and would allocate 20% of that to gold, that could mean it would need to acquire almost 150 tonnes of gold, at current prices. According to the head of the Ministry of Natural Resources, Alexander Kozlov, Russia’s gold production in 2020 amounted to 445 tonnes, almost twice that of a decade ago. Whether the new allocation to gold will be subsumed within the central bank’s current gold store, or if it might mean buying gold domestically or on the world market, are open questions.

According to the Kremlin’s spokesman, Dmitri Peskov, “this process of de-dollarisation is taking place not only in our country, but in many countries around the world that have started to have concerns about the reliability of the world’s reserve currency”. Like climate change, the death of the Dollar as the international reserve currency will upset many apple-carts.

Not that Russia sees the Rouble as the next global reserve currency; merely that it is taking steps to ensure that it is less exposed to the demise of the US Dollar. Rather it’s preparing for the apparently inexorable rise of China’s Renminbi as the Dollar’s replacement.

The use of the US Dollar in Russian/Chinese trade has shrunk from more than 80% to just over 20% in just seven years. The share of Russian exports to Brazil, India, China and South Africa invoiced in US Dollars plunged from 85% in the second quarter of 2018 to 33% in the first quarter of 2020.

With the US national debt now more than $28 trillion and set to reach 202% of the country’s gross domestic product (GDP) by 2051 according to the US Congressional Budget Office (CBO), there is less confidence that the US Dollar provides the kind of “safe haven” currency it has done previously.

It’s becoming increasingly likely that, as professor Avinash Persaud warned in 2004, “a couple generations of unpaid cheques are [going to be] presented to be paid” and that these ‘due’ checks “will push the US into a series of economic and political crises in the middle of the 21st century”. Persaud said that “within my life time, the dollar will start to lose its reserve currency status, not to the euro, but to the [Chinese] renminbi”. Not that the Renminbi is a dead-cert to become all-powerful. Persaud added: “the fate of the average Chinese today is to grow old before they grow rich, the fate of the average American is more uncertain than most imagine”.

What might replace the $?

The fate of the average American is today not only closely tied to the policies of President Joe Biden and his injection of even more debt into American society, but also to moves in such things as cryptocurrencies and Central Bank Digital Currencies.

While the former is an archetypal “meme” stock — a phenomenon that largely owes its success to social media hyperbole — the latter are advancing rapidly across the globe, as governments try to wrest control over money creation away from private cryptos and back into their own hands. Right now, the speed of technological advance and the bureaucratic pace of policymakers (outside China, anyway) seems to give the private cryptocurrency developers the upper hand.

Yet some governments want to use Bitcoin — the leading cryptocurrency — as legal tender. El Salvador’s President, Nayib Bukele, has said his country will become the first to make Bitcoin legal tender, if he can get the measure through the country’s Congress. That shouldn’t be difficult.

A small Central American country

El Salvador’s national currency was the colón until 2001, when it made the US Dollar legal tender too, joining Panama and Ecuador. Making Bitcoin legal tender means every El Salvadoran will need/want to use it, not just rich people. In an economy that is heavily skewed towards cash (about 70% of its citizens don’t have bank accounts or credit cards) but which has a very high penetration rate of mobile phones (about 1.5 per capita in a country of 6.2million) a digital wallet system might just work. It will also make life easier for the two million citizens who live and work outside the country and who annually send some $4 billion home each year.

There is one big obstacle to President Bukele’s ambition for Bitcoin to become the way to buy one’s daily lunch; transaction times with Bitcoin are currently painfully slow. A few per second, against tens of thousands by for example Visa. But if there’s one blockage that technology has proved it can overcome, it’s the speed at which things can be done; Bitcoin’s transaction rate will speed up.

Does this portend that cryptocurrencies will displace the US Dollar as the global reserve currency? It’s unlikely.

For one thing there are simply too many — several thousand, each of them struggling for dominance. And they are too narrowly held, too illiquid, too unwieldy to challenge the Dollar.

For another there is the considerable volatility in cryptocurrency valuations. Bitcoin has dropped by 37% in the past month and is 46% lower than its mid-April peak; Ethereum is down 22.5% in the last month and 37% lower than its peak in May; others (such as Dogecoin, Chainlink and Litecoin) have lost more than 30% in the last month. President Bukele’s popularity might slump if the citizens of San Salvador find their daily sandwich fluctuates hugely in price.

The US benefits greatly from what Valery Giscard d’Estaing (then the French finance minister, in the 1960’s) called its “exorbitant privilege” of having the world’s reserve currency — by which he meant that it could always simply print more Dollars. “Foreign lenders are likely to demand concessions on the terms for such massive external financing”, according to Stephen Roach, a former chair of Morgan Stanley’s Asia section. Forecasting a 35% fall in the Dollar by the end of 2021, he said “the dollar is now (October 2020) far more vulnerable to a sharp correction. A crash is looming”. That view has been hotly disputed — and we are already half-way through 2021.

Nevertheless it’s true that the low borrowing costs that have resulted from the Dollar’s dominance — everyone has wanted Dollars — has facilitated the accumulation of debt. Voluminous amounts of academic literature exposing the threat to economic growth posed by excessive national debt have been published. In 2010, a European Central Bank (ECB) research paper said “above a 90–100% of GDP threshold, public debt is, on average, harmful for growth”. President Biden wants the US to have greater economic growth — as no doubt does the “average American” — but US federal debt is likely to approach 109% of GDP in the fiscal year of 2021, and 130% by 2023. This presents a long-term threat to US economic growth, the Dollar — and the fortunes of all US political parties.

It’s impossible to see how the gradual shift away from the Dollar will play out. It’s going to be a bumpy few years. In this context, all one can sensibly do is try to preserve the value of one’s money. For us that means gold: widely seen as a store of value in difficult times but also, thanks to Glint, now a currency that is as liquid as fiat money. Gold may have fallen 7.5% from its August 2020 peak of more than $2,000 per troy ounce but is up 11% since its March slump, and 9% higher in the last year. That doesn’t mean that gold will continue to rise, but it might prove to hold its value against paper money in the long-term — and is certainly less volatile than cryptocurrencies.

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