I was sitting here writing about the U.S. dollar when I felt the earth shake under me. It was the 5.9 magnitude earthquake that hit Mineral, Virginia.
For a moment, I thought it was the collapse of the U.S. dollar, leading to the ground shaking. That wouldn’t be good for the U.S. dollar or the world holding U.S. dollar reserves. But have no doubt; the dollar will come crashing down, albeit in slow motion, which we should all be thankful for.
"The dollar is our currency but your problem." (Jim Connolly, US Secretary of Treasury, 1971)
Before we continue on the U.S. dollar, let’s look at my favorite asset – gold. As soon as the Federal Reserve took the unprecedented step of announcing that they would keep rates down till 2013, I was assured of two things.
Stocks would go up and gold would soar. And both have happened as I had imagined.
Gold has gone up by nearly 18 percent in the past month alone. And while the supporters of gold claim it to be a good inflation hedge, the detractors claimed that it is “non-asset” since it offers no gains via dividends or interest. As soon as US Treasurys gained the “non-asset” status themselves, gold gained more supporters and more buyers. Granted gold was down $60 Tuesday, but I am sure we will see $2,000 per ounce before the year is out.
Back to the U.S. dollar.
It would be a tremendous mistake for anyone to assume that a reserve status currency can remain the reserve status currency, regardless of the underlying macro policies. The death of the British pound sterling in the early to mid-1900s is a case in point.
One of the pillars holding up the U.S. dollar despite the dismal underlying fundamentals is the bond markets. You must have heard the talking heads on TV tout the U.S. dollar, based on the fact of “Where else can you go to park your reserves?” And this depth of the U.S. bond markets is one of the last bastions of strength for the U.S. dollar.
The bond markets around the globe are small and a fractured bunch with local laws prohibiting large scale participation from global players. But this is rapidly being remedied. Two factors are holding back the Chinese yuan playing a credible threat to the U.S. dollar for the reserve currency status.
One is that it is tremendously undervalued. And the second is the lack of depth in its bond markets.
Both of these are being addressed by China in urgent fashion. Hong Kong financial markets have become an active test laboratory for China to gauge market reactions before launching its final attack on the U.S. dollar.
With the local markets developing for the renminbi (RMB) based trades, it has partially opened the RMB to the world, but under tight controls. With the Dim Sum bonds (RMB based International bonds) it is testing world appetite for Chinese currency based bonds. And both of these experiments are gaining a lot of traction. Such is the appeal for these bonds in Asia that Bank of Korea is seeking a QFII license to invest in the China bonds.
According to a recent study by the ADB, developing Asia, Brazil and Russia now account for 11.4 percent of global outstanding bonds, the same as the combined share of France, Germany and the United Kingdom.
Of course, there are a number of obstacles including the incidence of transactions taxes, limited liquidity and even capital controls. Despite these constraints, flows into this space have continued to grow. In a recent statement, the Finance Ministry in Korea said that foreign central participation in local treasuries had increased from 8 percent to 28 percent during the 12 months to July 2011.
And as I have reported to you in the past, China has signed several dozens of bi-lateral treaties with countries to trade with each other in non U.S. dollar terms.
This will reduced the influence of the dollar significantly in world trade.
So as you can see, it would be foolhardy to ignore the assault on the U.S. dollar that is gaining momentum overseas.
I would recommend the orderly exit of your investment dollar out of U.S. dollar denominated assets into carefully calibrated non U.S. dollar investments overseas.
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