Analyzing currencies is weird, and most people don’t get it. Sometimes, I think I don’t get it. There is nothing fixed in our economic world, no fixed measure of value. Everything trades against everything else. Currencies exist to make the trading easier. Imagine a matrix that is millions by millions, with trillions of exchange rates for one good or asset against another. With currencies, it simplifies. Each nation prices out goods and assets in their own currency, and then currencies trade against each other, subject to arbitrage with commodities, and commodity-like assets.
Anyone who has read me for a while knows that I am not a bull on the US Dollar. But where I part ways with the grizzly bears (call me a teddy bear 🙂 ), is that the fundamental accounting identities must be maintained. Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.
It does not matter what currency crude oil trading, or any other trading, is denominated in; it does matter in what currency the proceeds from the sale of crude oil is invested in. So long as the US runs current account deficits, foreigners must acquire US assets in order to fill in the gap. In the past that has mainly been bonds — agency, mortgage, corporate, but increasingly Treasury notes.
It is not that easy to abandon the US Dollar. Where do you go? The yen will suffer for years as Japan heads into demographic decline and large structural budget deficits. The Euro is still an experiment; there are many pressures on it; its survival is mot assured. Nothing else is large enough or stable enough, or mature enough to run the deficits necessary to have the debt markets, to be the global reserve currency. As an example, China does not want to run deficits, nor is its financial system strong enough to bear the wear and tear of global use of its currency.
So, when reporters write pieces indicating the imminent demise of the US Dollar, I don’t buy their arguments:
Other parties disagree with the worry:
- Oil states say no talks on replacing dollar
- Saudi Arabia Denies Holding Secret Meetings To Kill The Dollar
If the money is not invested in US Dollar investments, where will they invest? That is the question.
Now, there are other issues. China could queer global trade by asserting that entities in China could default on obligations from derivative contracts and not worry about it. Why is this big? If a major country does not respect contract law, that country will not be respected in global trade. Granted, China is a creditor, not a debtor on net, but the ability to transfer capital is paramount in the global economy, and if China will not honor contracts, that will bite them.
Away from that, I was fascinated by Australia’s interest rate hike. It makes me bullish on the Australian Dollar, even after its significant rise. That said, don’t move too aggressively, because eventually US Dollar rates will rise.
My view is that the US is in a Japan-like funk, which it will not rise out of for years. I don’t think the Fed will move aggressively — they will be timid. It is easier to argue to Congress that they did their best but conditions were severe, than to argue that they headed off inflation, but many people were unemployed.
Unless Europe moves to a full political union, or China frees its economy, there is no real competitor to the US Dollar. Yes, the dollar will likely decline over the next decade, but it will not be likely to lose its reserve status, unless a commodity standard currency comes into being.