The death of the dollar means that, as business owners, we must prepare for continued pricing pressures, increased supply chain volatility and higher borrowing costs.
No, the U.S. dollar as a currency is not dying. Yes, the dollar as the center of the global monetary system is coming to an end. The dollar-centric system has been dying – or, if you prefer, transitioning – for decades.
As a result, the U.S. Federal Reserve Board will have increasingly less control and impact over what happens internationally. It will also have less leeway in how it goes about its business, managing interest rates as well as inflation and deflation here in the U.S.
The Death of Money: The Coming Collapse of the International Monetary System
Let me step back a bit. Flying from Minsk to Amsterdam, I had just finished reading The Death of Money: The Coming Collapse of the International Monetary System by James Rickards. He writes of the demise of the dollar-centric system in effect since 1944. Writing primarily for the individual investor, Rickards walks us through each respective end game: inflation, deflation, old-fashioned market collapse and new-fangled financial/cyber-wars.
As I wandered through Amsterdam Schiphol airport toward my connecting flight home, I wondered how much of his evidence was cherry-picked to prove his case. Entering the departure concourse, I saw a light box ad for the largest bank in the world: ¥en. €uros. RMB. A dollar-free ad. Let’s check some facts.
The U.S. Is No Longer Half of the Global Economy, Just 16%
At the time the U.S. dollar based system was born in 1944, the United States had a ±50% share of the global economy. By 1988, in the aftermath of the 1970s dollar crisis, the U.S. share was down to 26% on a purchasing power parity adjusted basis. And, by 2014, the U.S. share of the global economy was down to 16%. With the U.S. share dropping by two-thirds, why would we expect the dollar system to endure much longer?
The First World Currency Was Created in 1969
At the birth of the U.S. dollar system in 1944, the dollar was tied to gold at $35 per ounce. The 1970s dollar crisis began when then President Nixon suspended the dollar’s convertibility into gold. By 1978, inflation had reached double digits and the dollar system was on the edge of collapse. The International Monetary Fund (IMF) began to issue Special Drawing Rights (SDRs) as an emergency reserve currency. Since Nixon had changed the rules of the game, why would we expect that other countries would not begin searching for non-dollar alternatives?
The Euro Is a Reserve Currency Too
The creation of the euro in 1992 was in part a response to this dissatisfaction with the dollar world. Even the strongest of the European currencies -the British pound, German mark and Swiss franc – could not credibly become the global unit of account. The euro, aside from intra-European benefits, has offered a non-dollar alternative.
“The euro is also attractive to foreign governments as a reserve currency because of its strength and the confidence it inspires. In this way, they can spread the risks to their foreign exchange reserves by holding euro as well as U.S. dollars and other currencies.” – European Commission.
Fully functional in 1999, the euro took over where the German mark, French franc and other European currencies left off. At its outset, it had a 17% share of global reserves. Its highest share has been 27%. The latest IMF report shows a 20% share. Much of the euro’s growth as a reserve currency has been at the expense of the dollar, especially in the emerging and developing countries.
The U.S. Dollar Is Losing Share of Global Reserves to Canadian and Australian Dollars
According the the Bank of International Settlements, prior to the 1970s, 77% of global reserves were held in U.S. dollars. The British pound was a distinct second with just 10%, followed by the Swiss franc and Japanese yen. By 1984, the dollar share was down to about 65%. Since then, the dollar share has been as low as 59% and never higher than 71%. The latest IMF data shows a 63% share. In addition to the euro, countries – and companies – are more willing to hold reserves in non-U.S. dollar currencies like the Canadian dollar and Australian dollar as well as the Japanese yen, British pound and Swiss franc.
And Now the Chinese Renminbi (RMB) Is a Reserve Currency Too
Since 2008, the RMB accounts for much of the 2 to 6% of reserve share which the IMF lumps into other currencies. In fact, the RMB officially became a world reserve currency on November 30, 2015. Starting in October of 2016, it will account for almost 11% of the IMF total reserve currency, the SDR. Some still hold that the SDR is just a unit of IMF accounting. If so, then why has China lobbied so long and hard for the RMB to become one of the basket of SDR currencies? And, why did it matter to the U.S. that its percentage share of the basket not be impacted by the inclusion of the RMB?
To promote the RMB’s reserve status, China has launched the Cross-border Interbank Payment System (CIPS) as a (RMB-centric) electronic payments system alternative to the Society for Worldwide Interbank Financial Telecommunication (SWIFT). From Euromoney:
“Full convertibility, availability to trade, hedge and invest, and the desire to settle in RMB remain the driving pillars of CIPS’ future success, but the payment system marks an official moment to increase the efficiency of RMB around the world,” says Yang Du, head of Thomson Reuters’ China business desk.
Plus, Countries Are Buying Gold
Countries, with few exceptions, have been net buyers of gold since at least the end of 2008. Through Q3 of 2015, 26 countries together have net purchases of ± 3.2 thousand tons of gold. China alone accounts for over 1.1 thousand tons of net purchases. Russia and Turkey account for another third of the purchase volume. India, Kazakhstan, Mexico and South Korea account for an additional 450+ tons of net purchases. When Mexico, the U.S.’s third largest trading partner, made a 100+ ton purchase in the spring of 2011, the rationale was reported in the Financial Times:
“[The buying] seems to confirm there’s an appetite now among emerging economies with large forex reserves to add to their gold reserves…Gold is seen as one way in which to diversify away from the dollar- or euro-denominated assets.”
The five largest trading partners of the United States, represent 55% of the U.S.’s total trade. Each of these countries has at least one non-dollar reserve alternative, or is acquiring one:
- China (16% of total trade with U.S.) – ranks fifth among countries in total gold reserves and is actively turning the RMB into a competitive reserve currency.
- Canada (15%) – the Canadian dollar is a minor reserve currency (2%) but a reserve currency none-the-less.
- Mexico (14%) – is actively accumulating gold reserves to diversify away from dollar reserves.
- Japan (+5%) – the Japanese yen is a reserve currency (4%) and ranks eighth among countries in gold reserves.
- Germany (±5%) – is a euro country and is second only to the U.S. in gold reserves.
If your business has any international aspects, supply or demand, particularly if you do business with companies located in these five countries, you have, in all probability, been dealing with non-dollar terms on an increasingly frequent basis. If you have not, you will.
Where Will Your Business Be When the Music Stops?
Since the year 2000, U.S. public debt has grown from about $5 trillion to $18 trillion. The Federal Reserve Board’s stated policy solution to pay-off this debt is to generate and manage a 2% rate of inflation in consumer prices. And so, since 2009, the Fed has more than doubled the base money supply. Consumer prices, however, have not risen as desired. And, producer prices have, if anything, dropped.
However, there has been asset inflation in corporate junk bond debt. Total high yield or sub-prime corporate debt has risen sharply in the last six years, reaching $1.7 trillion. The latest news from the junk bond market is that no one is making a dumb bid. That is, no one is bidding the bonds any higher or even buying at current prices. Junk bonds are becoming illiquid. When did we last hear about a subprime market becoming illiquid prior to collapse?
Whether you believe that the Fed will be able to generate and contain inflation or that their policy tools are overextended and ineffectual, our trading partners around the world are hedging their bets against the U.S. dollar. And, we should be prepared.
How to Remain an Independent Business Owner
The Old Normal is gone. But, the New Normal has not come yet. We are in a transitional time of high volatility. We face continued pricing pressures, increased supply chain volatility and higher borrowing costs. So, what are independent business owners like us to do? For starters, I suggest the following eight items:
- Get multi-currency literate and conversant in currency hedging techniques.
- Get debt-free – eliminating debt in tiers beginning with most problematic and least productive.
- Build up cash reserves.
- Buy income producing assets core to the most profitable segments of your business, including land.
- Set net zero terms for customers; at the very least, get key customers current or otherwise within terms.
- Outsource non-core operations, including information technologies, as appropriate.
- Get Cash Intelligence – set-up management systems for signals and warnings.
- 80/20 your business – focusing on most valuable segments; at the very least, eliminate marginal segments.
I realize that a few of these are easier said than done. And, that not everything can be done at once. I believe the 80/20 principle is your friend. Start there.
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