Posted November 08, 2023
By Jim Rickards
The Great Dollar Paradox (Resolved)
The dollar has been extremely strong over the past two years. This persistent dollar strength has been a mystery to many. After all, the dollar’s problems are well known.
The ratio of government debt to GDP for the United States is at a record high approaching 130% (a prudent level is considered 30%, and anything over 90% is a headwind to any economic growth at all).
The U.S. is running multitrillion-dollar deficits year after year. The Congress and White House seem in the grip of Modern Monetary Theory, which claims that the U.S. can run unlimited deficits and accumulate unlimited debt without economic harm because it can print money in unlimited quantities to finance the debt and spending.
Meanwhile, projected annualized interest payments on the U.S. national debt exceeded $1 trillion at the end of October, according to Bloomberg. The cost of debt service has doubled in the past 19 months as interest rates have risen.
This fiscal profligacy comes against a backdrop of social unrest and political dysfunction. We’re facing a presidential election next year in which one candidate, Biden, is senile and the other candidate, Trump, may be behind bars on Election Day.
Take your pick. But the dollar keeps on chugging along. How can the dollar be so strong against such a dismal landscape?
There are two answers to this question.
Answer No. 1
The first is that the dollar has its problems, but other currencies are in even worse shape. For example, the Chinese yuan is on the brink of collapse being held aloft by non-sustainable intervention by Chinese banks.
The Japanese yen is joined at the hip with the yuan because of the extent of Japanese investment in China financed by Japanese banks. With the yuan going down, the yen will go down in sync.
So that’s two major currencies with problems.
Meanwhile, Europe and the U.K. have deindustrialized under the sway of the greeniacs pushing the Green New Scam policies. Now Europe faces a winter of freezing in the dark if cold weather is extreme and Russia decides to turn off the energy taps.
Germany, the largest economy in the eurozone, is heading for recession if it isn’t already in one, and the same is true for the U.K. That’s two more major currencies facing troubles.
So yes, the dollar has its problems, but as an investor do you really prefer sterling, euros, yen or yuan?
Answer No. 2
The second reason for the dollar’s strength is much more technical and not well understood, but it’s critical to grasp. You don’t need to nail down the technical details; it’s enough that you understand the bigger picture.
It involves the so-called Eurodollar.
Eurodollars are dollar-denominated deposits held at foreign banks, and therefore outside the jurisdiction of the Fed and U.S. banking regulations. Although they’re called Eurodollars, the banks where they’re deposited can be anywhere in the world. It’s a global system. The eurodollar market is actually one of the world’s major capital markets.
The Fed actually has very little influence over the global dollar market and the exchange value of the dollar. The old currency metrics of balance of trade and moves in capital accounts are leftovers from the world of fixed exchange rates, which have been gone for decades.
What drives the dollar is the Eurodollar market, as conducted by the world’s largest banks in London, New York and Tokyo. It’s here where global liquidity and interest rates are actually determined.
The Eurodollar market needs a constant supply of depositors parking their money in foreign banks, in particular to support derivatives positions. These banks face a liquidity challenge if deposits drop.
Right now, this market is in contraction.
Derivatives are being unwound, balance sheets are being trimmed and interbank overnight lending is being financed with collateral.
And these banks are demanding the best collateral. They won’t accept corporate debt, mortgages or even intermediate-term U.S. Treasuries. The only acceptable collateral consists of short-term U.S. Treasury bills, the shorter the better. This means 1-month, 3-month and 6-month bills.
Those are denominated in dollars, of course. In order to get the bills to post as collateral, banks have to buy dollars to buy the bills. This has created enormous demand for dollars. And that partly accounts for the strength of the dollar.
Again, it’s not important that you understand the intricacies of the eurodollar system, just that high dollar demand in the Eurodollar market is contributing to dollar strength.
The fundamental dollar shortage problem is not going away soon, and will continue to support the dollar.
What About a New BRICS Currency?
What about the prospect of a BRICS currency union and the move toward a new currency? I wrote a lot about that ahead of the BRICS Leadership Summit that took place back in August.
This new currency would be gold-linked and would displace the dollar in time as a major player in world trade.
Shouldn’t that be weakening the dollar?
After all, the prospect of a BRICS currency should pose a severe threat to the petrodollar, which is a pillar of dollar strength.
But this movement is still in its infancy and, unsurprisingly, is experiencing growing pains.
It’s not yet as unified as it needs to be if it’s going to seriously threaten the dollar. And one of those BRICS nations — India — seems to be playing both sides.
It was recently reported that India’s government is expected to reject demands from Russian oil companies to pay for Russia’s crude oil imports in Chinese yuan.
Russia currently has a surplus of rupees and is having trouble spending them. At the same time, demand for yuan has grown as Russia trades more with China.
Meanwhile, India mostly uses the dirham and U.S. dollar to pay for Russian oil imports. Basically, India is currently in a balancing act. They consider Russia an important economic ally while they consider China a geopolitical rival.
India fears popularizing the yuan will hurt its own efforts to internationalize the rupee. In fact, India was the only BRICS nation to oppose the introduction of a common currency, fearing it would benefit the yuan.
India’s refusal to give in to Russia’s demands leaves a significant role for the dollar, which is another reason to believe the dollar will retain its strength for the foreseeable future.
The Golden Ruler
Now, don’t get me wrong. I’m not saying the dollar is strong. It isn’t, for all the reasons I listed above. It’s just stronger than its competitors, and that’s why it appears strong.
Is there some way to tell if the dollar is actually getting stronger or weaker without making reference to other currencies?
Yes. The answer is gold. Think of gold as a ruler that measures dollar strength or weakness.
Gold has gained close to 10% over the past month or so. I expect gold to become much stronger, despite some temporary setbacks along the way.
Investors should consider today’s prices a gift and perhaps a last chance to acquire gold at these prices before the real safe haven race begins.
Below $2,000, gold is so cheap right now, it’s practically a steal. I strongly urge you to take advantage.