BITO - De-Dollarization Proceeds Apace

Summary

• The US Dollar is still the most important global currency,.
• The movement away from the USD is accelerating.
• The consequences for investors of progressive de-dollarization should not be undervalued.

This article examines the process of de-dollarization. Even though the USD dominates global finance, there is no guarantee that significant changes will not take place. Investors should pay attention to the performance of the greenback in Forex markets.

The US Dollar Reigns Supreme

There is no question that the USD dominates global finance. About 85% of all transactions in the global Forex market of 6 trillion dollars daily involve the US currency. Central bank reserves are comprised mainly in dollars. Global debt is primarily denominated in dollars. The US can carry trade deficits of $100 billion a month, and the currency even gains strength against other currencies. The Fed has begun raising interest rates, which has attracted foreign capital to the US as the greenback is considered a safe-haven currency in spite of the fact that the US federal debt ($31.2 trillion and rising) to GDP ratio is 121% U.S. National Debt Clock : Real Time . It is an anomaly that a country with an annual budget deficit of $1.2 trillion with annual spending of $6.1 trillion still has any credit at all. One can hardly be surprised that current inflation is rather high. The question of how much longer the USD can maintain its position should be asked.

Movement Away from the USD

Even before the beginning of the open conflict in Ukraine, there was movement away from the USD. Several bilateral agreements were made by various countries to enable direct commercial exchange without the need to involve US dollars. The rise of China as a global financial power meant that some global debt was denominated in yuan rather than dollars. Russia had begun a process of depending less on the US currency. Iran had long been subject to sanctions that prevented it from sourcing dollars for trade.

After February 2022 the sanctions imposed on Russia by the West resulted in Russia practically being cut off from the dollar economy. This has led to the creation of a market that avoids the use of dollars. The BRICS countries have been discussing various possibilities of creating an alternative international currency. It remains to be seen what China is going to do. The PBoC has over $1 trillion in US Treasury debt, and it is unlikely that the Chinese would be willing to lose that amount of money in an effort to dethrone the USD. Much more likely is a gradual divestment that would not cause disruption in the markets.

Another major player in international financial markets is Saudi Arabia. The relations between the Kingdom and the US have apparently deteriorated to a certain extent as the Russians continue to maintain close contact with Saudi authorities. It is widely known that the petrodollar system depends largely on the Saudi insistence on receiving payment in dollars as do many other major oil producers. In this case geopolitical considerations play an important role in how financial equilibrium functions. If the Chinese and Russians succeed in weaning Saudi Arabia away from the US, there could be great changes in Forex markets as there would be a lot less demand for US dollars.

The fact is that it is not only Russia that has taken a liking to de-dollarization. Brazil, China, India, Iran, Libya, North Korea, South Africa, Syria and Venezuela are all interested in de-dollarization even if for different reasons. Taking the argument to a global level allows the consideration that the Ukraine conflict has accelerated the movement away from the USD and prepared the way to the creation of an alternative or alternatives to the American currency. We may now be in a process of the creation of a bipolar financial world where the USD area is confronted with another system of exchange in the East and South. Australia, Canada, the EU, Israel and New Zealand constitute along with the US one bloc that is separate from the rest of the world.

Prospects for Investors

The US Dollar is unlikely to collapse any time soon as the major global currency. The greatest danger to the greenback at present is inflation since de-dollarization is going to take some time before its effect is fully felt. US investors have to grapple now with inflation. The bond market is in turmoil as the Fed raises interest rates. It is needless to note that the prices of bonds on the secondary market are heavily influenced by what the Fed does. The higher the yield on the current market, the lower the price of paper in the secondary market for bonds with low interest rates, and that means most of the market. It will also be much more difficult for zombie companies to refinance their debts. The conclusion is that the US is probably heading straight into a recession with investors moving into fixed income. The stock markets might suffer even if there are many companies that carry on with stock repurchasing programs. Under these circumstances investors may turn to value and companies that pay dividends on their stock.

There is also the question of whether it is a good idea to use highly valued dollars to buy foreign currency and invest abroad. Corporations are certainly encouraged to outsource production to take advantage of cheap foreign labor. The Swiss franc still seems to be a safe-haven currency and is certainly a better bet than the Euro that is now close to par with the USD.

The long-term consequences of de-dollarization will mean less demand for dollars and a fall of the value of dollars in Forex markets. This will mean increased costs for imports, and this will result in the further impoverishment of American workers already burdened with the impact of inflation. Wages will not keep up with the increase in inflation.

The entire process will probably be gradual, but one cannot rule out black swan events and a faster rate of de-dollarization. What is clear is that we are in the midst of tectonic global geopolitical shifts that will have deep and lasting effects on international finance.

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