Dusk and darkness for the dollar?

There’s a trend that has been in place for a while now, and it’s worth paying attention to.

Central banks around the world are dumping their U.S. Treasuries at record levels.

Bond trading is hardly a sexy subject, and permutations that make this kind of news back into something actionable can be tedious… but I’ll try to make this as straightforward as possible.

Let me take you back a little bit to the root of the problem.

The U.S. was just starting to see the value in outsourcing production of all sorts of products. And it saw that China, not then a major economic force, was a great hub for this production.

Not only did it have massive manufacturing facilities, but it had low regulations, a massive labor force and very low wages. This all meant bigger margins for the companies. It also meant that, for a while, lower prices would hide the devaluing of the dollar due to the inflationary Federal Reserve.

The U.S. outsourced and, while corporations benefited from this arrangement, the U.S. government realized it wasn’t winning as much as China was. All this business was helping China leapfrog out of the pre-Industrial Age it was stuck in when the old-school Communists were in control.

So, the U.S. and China cut a deal. The U.S. would continue to look favorably on China’s expanding role if China started buying U.S. debt (Treasuries). That meant the U.S. could keep printing money and inflating away because it had a known partner that would buy all that paper, regardless of its real value.

Also, don’t forget that because the U.S. dollar is generally the currency that all major commodities are priced in (oil, gold, copper, steel, wheat, etc.), anyone who buys these materials has to hold dollars to pay for the goods.

This all worked to keep the U.S. economy the most powerful on Earth and has worked for decades… until China started to become a real economic force of its own. By then, the U.S. was embroiled in an outrageously expensive war and the world was about to be rocked by a massive financial collapse that is still going on despite what you’ve been told by the mainstream.

All the central banks decided together that the best thing to do was… wait for it… print more money.

That worked great for the U.S. because it knew China would continue to buy its debt. Then cracks appeared in this arrangement. China became a leading energy importer in the world and the Middle East became a concern to their energy needs.

China felt that if the U.S. won Iraq and basically ruled the region, China’s main economic competitor would have control of China’s oil. Also, China was hoping to get the respect of the Western powers as an economic equal.

In the midst of this, Saddam Hussein announced that he was no longer interested in taking U.S. dollars (i.e., petrodollars) for Iraqi oil. It then cut a deal with China to sell oil for renminbi (the yuan) instead.

Then China started talking about shifting from the dollar to an index based on a basket of currencies. China now saw the advantage to get its currency more widely held if it wanted to be a global power.

The U.S. invaded Iraq in 2003 and we had a financial meltdown in 2008 which served to get this growing momentum of dumping the dollar as a reserve currency off track. Coincidence?

Today we’re starting again to see moves that look like there are a lot countries that have it out for the U.S. dollar.

In November 2016, China sold nearly $1 billion in U.S. Treasuries. This was the sixth consecutive month of selloffs and the largest amount sold since 2011.

What’s more, Japan is selling large stakes, as is Russia, not to mention European sovereign wealth funds.

Some of this may be profit taking in expectation of the U.S. rate rise in December. In some cases, it might be fighting devaluation of their own currencies like the renminbi and euro.

If this continues, it’s going to make U.S. policy difficult. If the Federal Reserve looks to raise rates there may be fewer buyers in the market to absorb the debt. That means the easy money may dry up, which could create a significant shock on the U.S. economy.

And while the dollar seems strong right now, and a weakening dollar may be good for exports, such weakening could be the first nail in the coffin for the U.S. dollar as the world’s global reserve currency.

Let’s face it, there are few countries left that see a strong dollar in their own interest. And nations like Russia and China are certainly not interested in the petrodollar.

Greenback fallout

What happens in the coming months regarding the Fed and the Trump trade policies could see a watershed move in U.S. Treasuries, the dollar and ultimately the economy.

If this scenario starts to unfold, the best thing you can do is unwind any positions you have in the big banks and financial institutions. Also, industries that rely on a lot of debt financing like utilities will come under pressure (but if you have a long time horizon, just be patient).

If you want to buy into this kind of crazy, your best bet is gold and silver. Not miners. Consumer staples may be a good flight to safety as well. Maybe health care.

The point is, if the U.S. dollar falls as the global reserve currency, there is going to be a long and ugly fight among other nations for a replacement. That kind of uncertainty will wreak havoc on the traditional markets.

Don’t wait until that happens.

— GS Early

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GS Early