What Is Dedollarization?

Hello everybody and welcome to Breaking the Dollar. I'm your host, Everett Millman. I'm a little bit under the weather this week so I apologize if my voice sounds a little scratchy. But duty calls and we have a very interesting topic this week. De-dollarization. Now this is something that you mainly hear about on the fringes of the financial news media until very recently. Now it's something that Bloomberg and Reuters and all of the mainstream financial news outlets have started to pick up on this trend of de-dollarization. So what are we talking about? What do we mean by de-dollarization? Does have kind of an ominous sound to it. It sounds very bad. It sounds like it means that the dollar is going away or is going to crash. But really it's not as bad or as big as it's made out to be. Simply put, de-dollarization is a trend toward foreign countries and foreign central banks limiting their exposure to the dollar.

The two most prevalent ways that we see this happening is countries literally trying to avoid using the dollar in international trade, which we tend to see with Russia and a lot of countries that are being sanctioned economically by the United States like Iran and North Korea. Besides that, part of what's driving de-dollarization is central banks of foreign countries actually reducing the amount of US Treasuries they're holding. So although that is essentially a loan those countries are making to the US government, you can think of Treasuries as cash in the future as future dollars. So this is something we're particularly seeing in the East with Russia and China. But increasingly, US allies in Western Europe have started to albeit slowly pick up this trend as well. They're usually not outright selling their Treasury bonds but they're letting them roll over. They're letting them expire without buying more. So in effect that reduces the number of Treasuries that they're holding.

Now this sort of begs the question, if we're seeing de-dollarization, what is it being replaced with? In the case of Russia, they've moved more toward the euro because they do want to facilitate an increased trade with the rest of Europe. In China's case, they have made a concerted effort to have their own currency, the yuan, become more prevalent not only in international trade but also in bank reserves. But more so than either of those two strategies is simply replacing the dollar with gold. And so this is a topic that has come up many times previously on the show where we focused on how central banks all around the world are increasing their gold reserves. They are buying more gold. Because the US dollar is the world's global reserve currency, it's sort of as good as gold. So if you're going to move away from dollars, the logical replacement would be gold itself.

Besides actually buying more gold, what we're seeing especially in Western Europe is countries are repatriating their gold. That means that they're bringing that gold back home. Especially in the wake of World War II when it wasn't necessarily safe to store your gold reserves in your home country if you were in Europe, a lot of countries sent their gold for safekeeping to vaults in London and New York. And there they have stayed for the better part of 50 years. But now you do have a lot of countries like Germany, the Netherlands, France, Italy, and even Poland are repatriating that gold. They're bringing it back home so that they can hold it and store it themselves. So this is definitely a growing trend. As I said, it's something that's coming up more and more often in the news. But I want to throw some cold water on the idea that this is going to be a world-changing kind of shift. You'll often hear people characterize de-dollarization as sort of a nail in the coffin to the dollar being the world's reserve currency or that it will somehow lead us back to being on a gold standard. I think both of those possibilities are incredibly remote, at least over the next 20 or 30 years. And the reason being is that it is just far too entrenched in the global financial system.

Now what do I mean by that? The dominance of the dollar as the global reserve currency, as the preferred currency in all trade around the world, is really unparalleled. It goes beyond even the dominance of the United States military around the world, which I'm sure everyone is aware of and would agree with that we are the dominant military superpower. We have military bases in basically every corner of the world. And that is an important part of what makes America the biggest economy in the world. By comparison, the importance of the dollar completely blows away how widespread our military power is. And I know that seems like a bold statement. Maybe it's difficult to wrap your head around. But the dollar is the pervasive mechanism of global finance and global banking. In terms of some basic statistics, about two-thirds of all of the currency reserves in the world, all the foreign exchange reserves held by governments and central banks, are in dollars. The same is true in international trade, in transactions between countries, more than two-thirds are conducted using the dollar.

Now there are other reserve currencies, which you could include gold in that discussion. Generally, it comes down to the Japanese yen, the British pound sterling, the euro, and sometimes people will throw in the Swiss franc and the Chinese yuan. Yes, other countries do hold some amount of these currencies as foreign reserves, but the dollar dwarfs all of them even combined. So even with this trend of de-dollarization, it really hasn't even put a dent in how important and how central the dollar is to the world economy. Part of the reason for that is historical, is that after World War II, the United States had essentially all of the gold in the world and the dollar was backed by gold. So we flooded the rest of the world with US dollars. At this point, there are trillions upon trillions of them out there. As I said, nothing comes even close in comparison. And that remained true even after the end of the gold standard.

Essentially, the replacement for that system is what is known as the petro dollar. So throughout the 1950s and 1960s, the United States secured agreements with Saudi Arabia for them to trade their oil to us. And at the time, interestingly enough, they would only accept gold. So the United States government was minting these large gold discs, not really coins, but kind of like large wafers of pure gold. And that's what we would trade with the Saudis in exchange for oil. With the death of the gold standard, instead, we got the Saudis to agree to take dollars and to only trade their oil for dollars with everyone else. So basically, if you wanted access to energy resources, you had to have dollars. Now, it doesn't get very much publicity anymore, but this same petro dollar system is still in place. It's why barrels of oil are denominated in dollars. And as much as we do look forward to there being cleaner and renewable sources of energy, there is no denying that oil is still the bedrock, the fuel that makes the global economy go.

Now, aside from this connection to crude oil, we also have to consider that there is so much infrastructure in global banking that is built up around the dollar. No matter where you look, no other currency or form of money can match how widespread and how widely used and trusted the dollar is. Sometimes you'll hear the acronym TINA, T-I-N-A, which stands for "There Is No Alternative." And really, that's the point that I want to stress here, is that no matter what happens with de-dollarization, there will not be a major alternative to the dollar in the next generation. When you start looking out further, 25, 30 years, now we're talking about the 2050, which I know sounds like it's the setting of a science fiction plot. But someday, year 2050 will get here. And yes, maybe then the role of the dollar will have shifted dramatically. But it will take that long for the current system to be changed. It is too firmly entrenched. The dollar is simply too powerful and important.

Given that that's the case, what are we to make of de-dollarization though? It does seem to carry some type of importance. And I think that's true. It is a sign of things to come. It reveals that the seeds are being sown for rivals to the United States to assert themselves in the financial system. Ultimately, I think it reflects a changing mood among other countries in the world about whether or not they want to be part of a dollar system and partner with the United States. Really, it does come down to a sense of distrust that is going on. And I think you see that with another topic that frequently comes up on the show, and that is the trade war. Really, de-dollarization is a geopolitical strategy.

But to circle back to my original point, I want to emphasize that this is the very early stages of that. This is the beginning. It's not going to change in the span of a year or two years or five years. It's more like it's going to take a generation for this to occur. And we should also keep in mind, it is probably not a coincidence that the dollar remains such a dominant force and that the United States holds by far the largest gold reserves in the world, over 8,000 tons, which is more than double, almost triple any other institution in the world. I don't think that's a trivial thing. At any time if other countries in the world did want to try and band together and agree to conduct trade or finance their banking institutions with something other than the dollar, essentially, the United States kind of has the goods to back it up, so to speak, based on the size of our economy, the power of our military, and in my opinion, the size of our gold reserves. Not to mention what I brought up before with the connection to the petro dollar. For better or for worse, there really is no escape from the dollar-denominated global system right now.

So I think that puts a nice little bow on that discussion and we will move on to our weekly question from the audience. And I really like this one. It comes from Seth B and Seth asks, what do you expect for the economy in 2020? That is the $64,000 question, isn't it? What's interesting is that we have to look back to what happened in 2019 to get a sense for that. And the general trend was that during the summer months, especially in August and September, pretty much everyone was afraid of an oncoming recession. And if you look in Google Trends, the search volume for recession spiked to the highest it's been since the 2008 financial crisis. But then subsequently, those searches fell, the markets rebounded, and everybody sort of regained their calm about them and recession fears subsided for the time being. You might call that a relief rally, that because the anxiety over a recession kind of got ahead of itself, there was a pretty natural bounce back in the other direction, which again is something that I think always happens in financial markets in the short run.

Along the same lines, we had the Treasury yield curve invert in 2019, which is invariably an augur of a future recession in the next year or two. And as things calm down later in the year, the yield curve uninverted. It went back at least slightly to a normal steepening curve. The reason I bring this up and what I think is important to keep in mind about that is that that's the exact same pattern we saw right before the last recession in 2008 and the following year. We did sort of have a market blow off to the top right after the worst moments of market sentiment hitting their bottom and everybody being fearful about a recession. But lo and behold, that only lasted for a few months. And then there was a financial collapse and the recession indeed happened.

So even in the absence of some Black Swan event or some major trigger that causes a financial crisis, I do think we will see a repeat of that pattern at some point in 2020 or perhaps early on in 2021. I'm always of the belief that the next recession is really an inevitability. And you just have to keep your eyes open and pay attention to the signs that it is soon approaching. So I think certainly in the next year, that will be something to look out for. I want to thank everybody out there for tuning in and listening. We really appreciate everybody checking us out. Be sure to listen to our next episode next week where I will discuss what is a Santa Claus rally and are we going to get one this year?