I was fascinated to learn more about Xi Jinping and Vladimir Putin’s three-day summit last week after I learned they had intensely discussed de-dollarizing their trade. Many people are unfamiliar with the fact most international trade is settled in U.S. dollars. Meaning each country will exchange their currency for the U.S. dollar for trade purposes, then re-exchange back to their currency once the trade is complete. The U.S. dollar is the world’s global reserve currency and largely trusted worldwide to retain value over other currencies.
Putin noted that he is in favor of using the Chinese Yuan for settlements of trade with countries in Asia, Africa, and South America (developing markets). At first, this does not seem like a big deal, but it unequivocally is. China is the world’s second largest economy and Russia is the world’s largest energy exporter; they are attempting to limit the U.S. Dollar’s dominance of world trade’s settlements.
After the Cold War ended, the United States was securely the world’s only remaining superpower. In the past 30 years, other economies and militaries, such as China, have closed the gap. One privilege that remains to the United States is that the U.S. dollar remains the world’s reserve currency. The U.S. can unilaterally apply sanctions to “bad actor” countries and spend freely as there will always be demand for foreign countries to hold the U.S. Dollar. This can be for trade, in the form of carrying our debt, or financing our deficits—at the end of the day, they need the U.S. dollar. As the world slowly (but steadily) looks for dollar alternatives, it may yield long-term political and economic headwinds, such as:
- The U.S. will have less power to use economic sanctions against foes;
- Interest rates will continue to rise as there is less demand for U.S. debt worldwide, pushing rates up;
- Inflation will likely remain above average as more currency is printed to fund deficits vs borrowing from abroad.
The U.S. Government has developed a lot of, what I consider, bad habits in the last 30 years being the unrivaled superpower and having the world’s unrivaled currency. Politicians have gotten comfortable spending without concern of deficits (note: the U.S. national debt is now above $31 trillion). Interest rates have remained low because of the dollar’s reserve status and worldwide demand for dollars. If demand for dollars weakens as a result of the dollar’s reserve status breaking down, the U.S. will no longer be able to fund massive deficits while keeping inflation and interest rates down. That change will be unpleasant to those who have not planned for it.
The question of the hour: What can you do? You can hold dollar hedges, commodities, and equities in the right sectors. These are among risks we will continue to discuss with you and advise on. Let us know if you’d like to discuss in greater depth.