How To Play The Demise Of The U.S. Dollar
The US dollar currently is the world’s reserve currency. What that means, other currencies are ‘backed’ by the dollar. Foreign central banks hold US dollars as a reserve, making their own currencies more valuable. It has replaced the previous standard, the gold standard because the USD was ‘good as gold.’ There seems to be an underlying fear that the US dollar will be ‘replaced’ by an alternative such as the Chinese yuan, Russian ruble, Arabic dinar, amero, or some other ‘One World Currency.’ We’ll display here facts proving that this is impractical for the next 20 years at least. The latest threat comes from Saudi Arabia. A new law would allow families of victims of the tragic events of 9/11 to sue a sovereign government, Saudi Arabia, for involvement in the attacks of some kind. WSJ has written an explanation of what it means and how it can impact markets: President Barack Obama ‘s trip to Saudi Arabia this week and pending legislation that would enable families of people killed in the Sept. 11, 2001 terrorist attacks to sue the Gulf kingdom have prompted fresh calls to declassify 28 pages of a congressional report said to describe links between Saudi Arabia and the terrorists. “If all of the information comes out and [the legislation] is passed we can move forward against the Saudis,” said Jim Kreindler, one of the lawyers representing the families of Sept. 11 victims. But is it really feasible, that the Kingdom sells huge amounts of US assets? Marc Chandler proposed the most recent analysis in a recent article on the topic : There is something else Saudi Arabia could do. It could take a page from the playbook of the former Soviet Union. When it saw how the US treated its special ally Great Britain in the Suez Crisis, the Soviet Union was wary of the US using its financial power for political ends; it feared that its assets in the US could be frozen. It took the dollars it had in the US and deposited them with a UK merchant bank. That merchant bank was able to lend out those dollars without the interest rate cap that prevailing in the US at the time. This is to say that the offshore dollar market was launched not by good capitalists and the internationalization of savings, but the Communists seeking to move out of reach of US officials. Saudi Arabia could do the same thing. It could takes its US Treasury holdings and bring them to a foreign custodian, who is not subject to US laws. This may be more difficult to do with some of the other assets it may own in the United States. Overall this course would prove to be less disruptive for it than selling Treasuries. That means, there are a number of practicalities not considered by those who promote this idea that somehow a foreign power such as Saudi Arabia, China, Russia, or others; could trigger a US markets event that could lead to a run on the US dollar. Could it happen? Of course. But if it did happen, even in the worst case scenario, there are number of protections in place (similar to ‘circuit breakers’) that would prevent something extreme. Electronic markets mean that on the one hand, information ripples around the world at light speed, and institutions can make decisions in seconds and with 1 click sell or buy trillions in assets. But on the other hand, they have allowed the consolidation of control into one power. In the case of the stock markets, that’s the exchange. The NYSE reserves the right to halt trading or implement other measures, should a situation such as 9/11 occur. This has never happened in currency markets, but if it did, the Fed could literally halt US dollar markets around the world. Because the Fed controls all US dollar payments. It could be impossible to ‘sell’ the dollar, at a rate that would create severe decline. Also remember that the Fed works in conjunction with other central banks, to provide US dollar funding (among other functions): In response to mounting pressures in bank funding markets, the FOMC announced in December 2007 that it had authorized dollar liquidity swap lines with the European Central Bank and the Swiss National Bank to provide liquidity in U.S. dollars to overseas markets, and subsequently authorized dollar liquidity swap lines with each of the following central banks: the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, Sveriges Riksbank, and the Swiss National Bank. Those arrangements terminated on February 1, 2010. In May 2010, the FOMC announced that in response to the re-emergence of strains in short-term U.S. dollar funding markets it had authorized dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. In October 2013, the Federal Reserve and these central banks announced that their existing temporary liquidity swap arrangements–including the dollar liquidity swap lines–would be converted to standing arrangements that will remain in place until further notice. And remember – currencies are traded in pairs – so if the US dollar is ‘sold’ – something must be ‘bought’ – it’s not like a stock. It’s not possible to sell the US dollar without ‘buying’ something else, such as the Euro, Pound, Swiss Franc, or Gold. Looking at it from one perspective, although forex markets are completely unregulated, they are also completely manipulated. That’s because the central bank controls its own currency completely. Central banks cannot control other currencies, only their own – which is why they usually work together, through institutions such as the BIS. In any event, during a currency crisis of any kind, like minded nations would turn to each other and the BIS. But investors must understand that modern Forex is a closed system, as explained in detail in the “Splitting Pennies” book. If any currency poses a threat to the US dollar – it’s bitcoin, not the yuan. That’s because bitcoin is not manipulated, and not inside the forex system – it’s an externally manufactured currency, not created by a central bank. The problem with our modern forex system is that there are 10 myths for every 1 fact, and they don’t teach it in school. Finally, these fears about China somehow smashing US markets by a fire sale are completely unfounded. First, China is incapable of managing its own economy . They say the western fiat economic monetary system is a ‘Ponzi’ – if it is, then China is a super- Ponzi . Don’t forget the history – China’s economy is just about as old as the Forex market itself. It needs time to evolve and grow. There are still many elements in the Chinese economy which are missing, but are necessary for a financial world leader capable of managing a world reserve currency. Yes, they are taking steps, such as the recent gold price fixing . But these are baby steps, it will take decades before China can crawl, walk, and finally run. At the moment it relies on US support, financially, politically, and economically. The US is currently China’s biggest customer. It’s a cozy relationship – the US prints US dollars and sends to China, China sends manufactured junk to the US. This is one leg that supports the US dollar, created by Richard Nixon. The other leg being the petro dollar system. By recycling US dollars in US markets, it ties China to the US as well, provides natural demand for USD. For China to completely abandon this system, would crash their economy. America is capable of producing cheap junk, should the need arise. It would even be politically popular, and regenerate the US manufacturing sector. But China is incapable of creating by itself, a world class banking system. They need western involvement, even if it’s a simple copy and paste operation. China is not Japan – it can take China 100 years to adopt western systems, or longer. They have long term thinking, which is a good thing generally, compared to the quick timeline of Western thinking. But insofar as there is any threat to the US dollar, from China, Saudi Arabia, or elsewhere, it’s preposterous. So although we have debunked these myths about the fallacy of real paradigm shift in regards to the US dollar, all these new players may provide pressure on the US dollar, as some choose to sell their US assets in favor of new systems, especially regional players who until now, didn’t have a choice other than the USD. Currently the US dollar has a monopoly on the global Forex market which isn’t a good thing. Competition is healthy, it will ultimately make global markets more stable. At the end of the day, the US dollar is supposed to create an environment for markets to exist, not be a market itself, which it has become. Ways to trade the fear of US dollar Demise 1. Short USD ETFs (NYSEARCA: UUP ) and (NYSEARCA: USDU ). ETFs offer great alternatives to Forex because of their availability in stock markets, and their wide variety of options. UUP has options going out 2 years, to 2018, with decent liquidity. By trading options on an ETF, you have the security of US regulations and the security of US protections against fraud. Broker-dealers don’t go bust often like Forex brokers do, and are regulated by FINRA. Also, for some it may be convenient to hold these contracts in the same account for which you do your other investing. 2. Long Gold & Silver. There are many ways to play gold and silver. The most popular gold ETF is (NYSEARCA: GLD ) and the most popular silver ETF is (NYSE: SRV ). Similar to other ETFs, deep out the money options provide a great way to play this strategy, and will provide the best bang for the buck. One futures strategy employed by some traders, to buy the Gold contract and not roll it over, thus receiving delivery of the underlying. Futures trading offers a great alternative to stock ETFs , as you would be trading the actual commodity itself, in this case Gold & Silver. 3. Long Forex banks Any bank that utilizes multiple currencies, such as Everbank (NYSE: EVER ), will profit from their strategic positioning. Banks who do business in emerging markets, who will capture this new Forex business, will profit too. The point here is that when China comes online completely, it will be a good thing – it’s a new customer. Don’t worry though, markets will be organized by western banks for as long as all of us are alive. We just have too much of a head start. In conclusion, be wary of claims made by those who do not fully understand how the global Forex system works. The US dollar will have less and less role to play in the world – US dollar hegemony was an accident. Forex was an accident, created by a US President, Richard Nixon. At the same time, Nixon opened China, and we are now seeing the result of those protocols – China is close to having a real free market system (just remember to bring your stomach medicine if you visit, or bring your own food and water). Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.