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trade friction disrupts dollar dominance

From Birch Gold Group

Sometimes it feels like the U.S. drinks a little bit too much of their own “dollar domination Kool-Aid.”

It seems like the U.S. assumes foreign countries will just keep storing the bulk of their forex reserves in the greenback. And as a result, the country keeps running deficits and borrowing cheap money year after year.

But now, as the U.S. invokes different measures of protectionism, and tensions build while the U.S threatens to pull out of NAFTA completely, it may be time to put that assumption to rest.

According to a recent report at the Wall Street Journal, a “whole new threat” for the dollar is emerging:

As the U.S. pulls back from partnerships while countries like Mexico and Japan strike their own trade deals, the dollar’s dominance could be undermined, investors and analysts said. That dominance has been referred to as an “exorbitant privilege,” allowing the U.S. to borrow cheaply and run persistent deficits.

This new threat comes on top of trade wars with China, and military tensions in Syria. Oddly enough, some members of the Administration were welcoming the idea of a weaker dollar amid tension created by the U.S. pulling the plug on NAFTA.

The “weak dollar optimism” is being seen as a departure from the way the U.S. normally implements currency policies.

From a Reuters report this past January:

U.S. Treasury Secretary Steven Mnuchin welcomed a weaker dollar on Wednesday, sending the greenback reeling and under-lining concerns that U.S. President Donald Trump is stepping up his attack on China and other big trading partners as part of his America First agenda.

Mnuchin made the remark, seen by markets as a departure from traditional U.S. currency policy, at the World Economic Forum in Davos, where other world leaders have made swipes at what they see as U.S. protectionism.

The news also had some experts like Jens Nordvig from Exante Data predicting a large shift of currency reserves topping $200 billion into other currencies like the yuan and euro.

So while “America First” trade policies might sound good on the surface, the implications for the dollar hang in the balance…

Why “America First” Could Mean “Dollar Last”

The “Kool-Aid” of trade protectionism the Administration is drinking might be summed up by an excerpt from a book review of Clashing over Commerce: A History of US Trade Policy in The Economist, which highlights an opposing view (emphasis ours):

Mr. Irwin also methodically debunks the idea that protectionism made America a great industrial power, a notion believed by some to offer lessons for developing countries today. As its share of global manufacturing powered from 23% in 1870 to 36% in 1913, the admittedly high tariffs of the time came with a cost, estimated at around 0.5% of GDP in the mid-1870s. In some industries, they might have sped up development by a few years. But American growth during its protectionist period was more to do with its abundant resources and openness to people and ideas.

If Mr. Irwin is correct, the U.S. dollar will be shuffled out of currency reserves and be replaced by currencies with more promise. This will make global trade markets less “U.S.-centric” and weaken the dollar.

And it looks like there are signs that he’s on the right track…

Returning to the recent Wall Street Journal report, the percentage of currency held at Central Banks in U.S. dollars is the lowest in years, while the euro and yuan are both on the rise:

Central banks held about 63% of their reserves in U.S. dollars at the end of last year, the lowest level in four years, according to data from the International Monetary Fund. Meanwhile, allocations to the euro rose to 20% and reserves held in the Japanese yen rose to 4.9%.

And even though there has been some recent optimism that the Administration won’t completely “rip up” the NAFTA agreement, that optimism is seen by experts as a “paper tiger.”

Plus, the “America First” stance is pretty firm, and it appears that stance will guide the outcome of the recent trade news. The Administration is standing behind the idea that weakening the dollar will help exports and the U.S. economy.

Bill Owens at WAMC thinks we’re on a course to continue the trade wars:

This pronouncement when coupled with Mr. Trump’s anti-trade rhetoric, including his threats to tear up NAFTA, his criticism of the EU trade pacts, the withdrawal from TPP, and other assaults on global trade would seem to indicate that he will proceed along a path that will incite trade wars.

While talking about China, Pippa Malmgren stated in a video interview that Trump’s trade policies are like playing a “high stakes game of poker.”

All of this is contributing to a disruption of the U.S. dollar as the dominating world currency. Nearly every global exchange rate is in a downward trend, and…

According to the St. Louis Fed, while the dollar depreciation subsided in March, the value is much lower since the beginning of this year, following a dramatic slide in 2017.

But it’s an observations from the Fed on why the decline seems to be continuing that may be the most troubling (emphasis ours)…

Whether those are also associated with a permanent realignment of the engagement of the U.S. economy with the rest of the world.

It should be noted that big changes are on the way…

The Silver (And Gold) Lining

Precious metals are historically proven to appreciate in value whenever the dollar falls. Asset management firms are seeing the potential, and moving funds into gold as a result.

A strategist at Bank of America even stated recently that gold may be headed for $1,450 before the end of the year.

So while the future for the dollar is troubling, it poses an opportunity for those holding gold.

 

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