Monday, August 26, 2013
Is The Dollar's Reserve Currency Status At Risk?
A friend sent me the following email:
“Chris, how concerned are you about the US losing global reserve currency status in the foreseeable future? Have you ever heard of Stansberry Research? This guy predicts US monetary and fiscal policy (massive debt, cheap money, etc.) is already causing flight from US dollars around the world. As the trend continues, the day will come when we’re no longer the reserve currency, and there will be a massive inflationary shock to US economy with enormous erosion in incomes, asset values, etc. He advises investments in gold, silver and non-US based assets. He lays out a well-reasoned, fact-based analysis. Very interesting. Do you have a take on this?”
Yes, I do have a take on Stansberry’s opinion. I don’t agree with it. It is built on false premises and faulty analysis.
The false premise is that “US monetary and fiscal policy (massive debt, cheap money, etc.) is already causing flight from US dollars around the world.” It’s not. The dollar remains by far the leader in international reserves: almost three times bigger than the euro ($3.8T vs $1.4T). Here's the link: http://www.imf.org/external/np/sta/cofer/eng/
America’s debt is not yet "massive", Treasuries are Aaa (unlike Japanese, French and British government bonds), and dollar credit is not cheap in real terms. America remains a very attractive place for foreign money. Furthermore, East Asia has nowhere else to invest their reserves. No other bond market is deep enough, except for Japan, and everyone is full up on JGBs. (What do you think the ECB uses as its reserve asset?)
In order to intervene effectively in the FX market, central banks need to own large quantities of assets that are liquid, safe and stable in value. This means foreign government debt. No other government security in the world can compete with Treasuries. Remember, the reserve asset must have a liquid market at all times. That’s Treasuries, and nothing else. Remember: neither the ECB nor the EU issue bonds. Euro-denominated government bonds are issued by the member states of which Germany is the benchmark.
Stansberry says that, when the world wakes up to the worthlessness of the dollar, there will be a massive inflationary shock to the US economy. Now that’s really dumb. If the world should ever dump the dollar, the shock will be deflationary, not inflationary. A dramatic rise in bond yields is deflationary and will produce a monetary, economic and fiscal convulsion. Yes, the Fed can offset this with inflation, but that is a counter policy. Rising real interest rates are inherently deflationary.
Why do you suppose that when there is a financial crisis, the world's central banks ask the Fed for dollar swap lines? Because their banks are indebted in dollars, which they can’t print. The dollar is the currency of global finance; it has no competition.
Furthermore, a factoid that the gold community tries not to mention is that the dollar has appreciated for the past two years while gold has depreciated. If there is a run, it is from gold into dollars. How liquid do you suppose the bullion market is, when you need $30 billion on a moment’s notice?
Who are the competitors of US Treasuries? Basically, JGBs, gilts and Bunds. JGBs yield nothing, and the Bund and gilt markets are not big enough for the conduct of major monetary operations. When the BoJ or the PBoC want to intervene in the FX markets, they use Treasuries, not Bunds or gilts or gold. Both the euro and the yen are, today, story paper. Central banks don’t buy story paper (not even in Latin America). The almighty dollar is still the almighty dollar, with a growing economy, low inflation, and a rapidly declining fiscal deficit. There is no alternative.