- An increasingly belligerent attitude from both the US and China over trade tariffs.
- A huge US budget deficit.
- A slowing global economy.
- Destabilisation of Hong Kong.
- Repatriation of gold reserves by numerous countries.
- Ongoing state purchases or production of record quantities of gold.
- The continuing advancement of cooperation between the BRICS group of developing nations of Brazil, Russia, India, China and South Africa.
It would be very easy to see all of the above as individual events relating to their own specific causes, but what if they are all potential components, triggered by US Trade policy, of a series of events that will lead to the destruction of US Dollar value on the world stage?
America First
The effects of President Trump’s well-rehearsed mantras of ‘America First’ and ‘Make America great again’ are probably most noticeable in the increasing trade war between the US and China. The initial tariffs imposed on Chinese imports into the US, with threats of more to come if the Chinese failed to cooperate, led to retaliation from China in the form of tariffs on US products. Some experts believe that after just two years this trade war is already having an undermining effect on the global economy in general. These two economic giants represent approximately 40% of the global economy between them and an already contracting global economy is unlikely to benefit from hostility between its largest members.
The additional factor of perceived US military power is also an issue to be considered. The US military establishment is enormously expensive, with a budget of over $700 billion recently approved by Congress. This spending has to be justified and in light of recent US disengagement from the Middle East, Russia and more recently China are identified as the major potential threats.
Whilst Russian nuclear assets are considered to have excellent capabilities, the ability of naval and army resources to operate effectively is often questioned on the basis of outdated technologies and unreliable engineering. The US Government’s insistence that Russia’s perceived goals of controlling global oil supplies and enlarging their territorial control justify the huge military budget is very much harking back to the attitudes during the Cold War and are not necessarily factually based.
China, on the other hand, has developed an impressive military force in recent years and extended its sphere of influence and territorial claims, particularly in the area of the South China Sea, as yet unchallenged directly by the US.
If the US aim truly is ‘America First’ then US thinking must be that China needs to be constrained from continuing with a rapid increase in influence, most notably in central Asia and Africa, where Chinese companies and huge investments are building massive infrastructure projects.
The growth of the Chinese economy and military stand testament to Chinese ambition that no longer appears to be constrained by Cold War era style bluster and military prowess on the part of the US. This leaves the US with the question, ‘If projected military strength cannot contain China’s global growth of influence, what can?
The US Deficit
Whitehouse.gov states that the difference between US Government spending and received revenue was a $1.09 trillion deficit in 2019 and is projected to be a £1.10 trillion deficit for the 2020 financial year. However, a US deficit, even at this eye-watering scale, is not necessarily perceived to be a problem. Governments will often run deficits as the additional money pumped into the economy will benefit the population with the ability to spend more and increase growth.
In the case of the US economy there is also an additional ‘safety net’ at play, US Treasury Bonds that provide guaranteed interest on loans to the US Government.
The US has had the world’s largest economy for almost the last 150 years and currently accounts for approximately 25% of global trade. That world dominance over a long period has led to the situation where the US Dollar is the most recognised and desirable currency on Earth and Dollar value is used as the settlement method for global trade.
Most nations that trade with the US hold ‘foreign reserves’ of Dollar value in the form of cash and Treasury Bonds or Treasuries. China is thought to hold foreign reserves of around $3.1 trillion, most of it in USD with about a third being in the form of US Treasuries. Treasuries are popular throughout the globe, primarily because the US Government has never defaulted on these loan agreements.
The popularity of US Treasuries holds an additional advantage for the US Government in that they provide a stable source of low cost financing of the US deficit.
A deficit may well not be harmful but perceived wisdom is that deficits should be paid down during times of economic growth. Perceived wisdom that the US appears to be ignoring at present.
Global Slow-Down
It is widely accepted that we are experiencing a general slowing of growth in the global economy. The US/China trade difficulties appear to be exacerbating the situation with some observers even suggesting that cyclical depression plus a trade war could trigger yet another global financial crisis.
In the event of serious decline in the global economy, nations are likely to repatriate funds in order to support their own economies and this would result in the selling off of US Treasuries and the liquidation and withdrawal of other investments from the US.
Widespread recession generally has the effect of pushing up interest rates at a global level. The combination of buying back Treasury Bonds, reduced investment into new Treasuries and the resulting need to borrow on the more expensive global markets may well seriously impact the US economy or at the very least lead to an increase in money printing or Quantitative Easing as it tries to cover the deficit.
Destabilisation of Hong Kong
The recent series of escalating protests in Hong Kong by the Umbrella Protest groups has secured a great deal of coverage throughout the world’s media outlets and has reportedly damaged the local economy and reputation of the former British colony.
As a major gateway into China for overseas investment funds, Hong Kong’s financial markets also suffered in the early days of the protests and disruption with some investors moving funds and even physical assets such as gold bullion to safer storage locations, primarily Singapore. Recent improvements in the performance of the Hong Kong markets have reduced the impact on the flow of investments into China but the situation is still volatile and will be of concern to the Chinese Government.
The acceptance of the Hong Kong Human Rights and Democracy Act by the US House of Representatives in November 2019 was heavily criticised by China as interference in internal affairs and the Chinese warned of ‘counter measures’ if the US continued to support protestors in Hong Kong. China has often expressed the view that the recent unrest in Hong Kong was instigated and is being supported on behalf of the US.
Bringing Gold Home
As the spectre of global economic slow-down becomes more visible, many countries are re-patriating some or all of their gold bullion reserves which have historically been held in the US and UK. Poland, Austria, Germany, Netherlands, Hungary, Turkey and Belgium have all taken possession of their gold assets, mainly from the US Federal Reserve Bank of New York.
It is also reported that Romania plans to repatriate 60 tonnes of gold that has spent the last 20 years on deposit in London.
State Purchases of Gold
In November 2019 The World Gold Council revealed that global central banks collectively bought 374 tonnes of gold, worth almost $16 billion, in the first half of 2019. These purchases were led by China, Russia and Poland and are seen as efforts to move foreign currency reserves away from the Dollar by using them to purchase gold.
The BRICS group of nations
The BRICS group of nations; Brazil, Russia, India, China and South Africa was originally formed in 2009 as BRIC before admitting South Africa in late 2011. The aim of the group is to encourage commercial, political and cultural cooperation between the nations.
Their most recent annual summit, the eleventh, was hosted by President Bolsonaro in Brasilia from 13th November 2019. Amongst the subjects under discussion was the group’s New Development Bank (NBD) and its role in providing funding for infrastructure and sustainable development. The development of a common cryptocurrency was also discussed, aimed at reducing the impacts of currency volatility. Such a development could also act as a common settlement medium for trade between BRICS members.
On 12th December 2019, the BRICS Information Portal carried a post with the headline, ‘American Isolationism is Drawing China and Russia Closer Together’ attributed to the South China Morning Post. China’s President Xi, commenting on the development of a major gas supply pipeline between China and Russia, reportedly said that the development of Sino-Russian ties would be a “foreign policy priority for both our nations.” The post also included the comment that “Closer cooperation between China and Russia does not mean foregoing efforts to improve relations with the US. Trump’s policy of pressuring rivals and allies alike on trade and technology is counterproductive.”
China’s Viewpoint
For many western businesses, China is a notoriously difficult place in which to succeed. The reasons are numerous and varied but often revolve around differing cultural values and processes. These, often very nuanced, differences can be perceived as deliberate obstacles, disinterest or even protectionism both by individuals and the wider state.
Throw-backs to the former hard-line Communist state including enthusiastic copying of a good idea or design still exist whilst the previously common requirement to bribe individuals in order to receive a desired outcome is being aggressively fought by the current government.
Secretive attitudes and a belief in the possession of a strong military force are also echoes from the past that can still be seen in other former-communist states.
In 1978 China began the process of opening up and reforming its economy, posting average year on year growth figures of near 10% and becoming the world’s second largest economy, raising 850 million of its population out of poverty in the process. This impressive growth was based on resource intensive manufacturing for export combined with low labour costs but China is now trying to restructure the economy towards higher-end manufacturing and services together with increased consumption within China. These changes are designed to satisfy the aspirations of a more developed workforce and to fund improvements in the provision of services such as healthcare. Focussing on a clear and fair business environment together with the strengthening of the regulatory framework are also seen as necessary improvements.
Whilst the Chinese and Western cultures are very different, it is useful to view recent global events from China’s perspective:
During the period of China’s exceptional economic growth, the West, and the US in particular, was only too happy to buy low cost, mass produced items from China in order to satisfy demand for consumables. Because of the dominance of the USD in world trade, China amassed considerable wealth in Dollars but then faced the reality that the US controls the Dollar.
As China’s exports grew in value, US sentiment began to sour towards them, linking US job losses to mass production in China.
In 2009 China began to reach out to similar emerging economies and BRIC was established.
In 2015 China achieved IMF reserve currency status for Renminbi currency as a way to limit US influence on China. Whilst there has been some traction in increasing the use of Renminbi in international trade, progress is slow and the Dollar still dominates.
In 2019, in the face of increasingly harsh tariffs from the US, China and the other BRICS nations discussed a further potential challenger to the dominant state of the Dollar, a common crypto currency that could be used between the members in settlement of trade deals.
Combining the different threads
So how might these different threads combine?
At present China is locked in to the use of the Dollar for the purpose of global trade and therefore has been forced to accept US tariffs whilst developing alternative markets and alliances.
This situation suits the US very well as it gives the Dollar value as the leading global currency and ensures a ready inbound stream of finance into Treasuries that offsets the domestic deficit.
However, signs of a downturn in global trade are already encouraging many nations to become more isolationist, taking decisions aimed at protecting their own economies in the event of a new recession. The movement of gold reserves back to the countries of ownership could easily be the first signs of a much broader repatriation of funds, including those currently held in US Treasuries.
A serious escalation of the US/China Trade War could well disrupt global markets sufficiently to accelerate this process.
Running parallel to this issue is China’s obvious intention of weakening the dominance of the Dollar in world markets. Having had only limited success in promoting the Renminbi, China appears to be encouraging the BRICS nations to explore the option of a common crypto currency for use within the group to settle trade deals.
A recent speech by The Governor of The Bank of England, Mark Carney, to the Jackson Hole Symposium in August 2019 provides fuel for speculation that some form of technical solution for trade settlements on a global basis would be generally welcomed by sections of the global financial community. Mr Carney described the concept of a Synthetic Hegemonic Currency (SHC) which could dampen the domineering influence of the US Dollar on global trade as intriguing.
Does this indicate an opportunity for the BRICS crypto currency to gain support globally? Probably not, since the world is unlikely to consider such a potentially volatile system to service world trade. But what if that crypto currency could be backed or guaranteed in some way?
According to the World Gold Council, in 2018 China mined 400 tonnes of gold, Russia mined almost 300 tonnes, South Africa mined 129 tonnes and Brazil mined 97 tonnes. That quantity of gold, together with existing holdings and re-patriated holdings may collectively form the type of guarantee behind a monetary system that could find enough global support to dislodge the Dollar from its position as the ultimate global currency.
Events and processes may well be aligning such that if the US chooses to become more inward looking and isolationist then its role in the world, and consequently its currency, will become less relevant and less desirable.
