Dollar Takes a “Pounding”

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You’ve probably heard that the U.S. economy is heavily “financialized.” What does that really mean? What is financialization?

It’s a big topic and not very well defined. It can refer to the dominance of financial activity over traditional business activity in goods and services. It can refer to market bubbles. It can refer to the use of financial instruments in non-traditional arenas such as warfare or political witch hunts.

In fact, it refers to all the above and more. Investors need to understand financialization in order not to be blindsided by market activity that defies fundamental analysis.

We can begin our review of financialization with a look at the role of the U.S. dollar in global transactions.

This is not a technical article detailing the plumbing of the financial system. But in considering the role of currencies in global finance, it’s important to distinguish between reserves (basically a nation’s savings account) and payments (transactions, trade, etc.).

The Dollar Still Dominates

The denomination of global reserves today is approximately:

• 58% U.S. dollars and 20% euros
• The remaining 22% is divided among yen (6%), sterling (5%), Canadian dollars or CAD (2.5%)
• And other currencies are each less than 2% (AUD, CNY, CHF).

In payments (measured in SWIFT message traffic), the U.S. dollar is about 59% of payments, with the euro at 13%, yen at 6%, sterling at 5% and yuan and CAD at about 3% each. All other currencies are less than 3% each.

The relatively larger role of the dollar in payments is due to higher oil prices and oil being denominated in dollars. SWIFT message traffic is almost exclusively interbank payments among large banks. There are many bilateral payments (for example, Russian payments to India in local currencies) that do not go via SWIFT.

There is no immediate threat to the role of the U.S. dollar in either reserves or payments. I recently debunked the fake news that Saudi Arabia has just ended the petrodollar deal that’s been in place since 1974.

Instead there’s a slow, steady erosion in the role of the dollar that could accelerate in the future. A good case study is the decline of sterling. In 1914, it was the dominant reserve and trade currency. By 1944, it had largely been displaced by the U.S. dollar as a result of Bretton Woods.

Slow Death

Today, sterling is barely a footnote in global reserves and payments. Still, that decline took 30 years (1914–1944) and continued for another 80 years (1944–2024). Major currencies don’t simply disappear overnight, but they are subject to these types of declines and gradual displacement by alternatives.

Contrary to what you hear from a lot of fringe analysts, the Russian ruble and Chinese yuan will not displace the U.S. dollar. Neither currency is widely accepted outside its home country. Those currencies have limited uses and lack large liquid bond markets, and their source countries lack a rule of law. Notions of a “gold-backed yuan” are nonsense. China simply doesn’t have enough gold.

A BRICS currency is a more likely alternative to the dollar for global payments. It won’t be issued for several more years. The BRICS are currently expanding their membership and will expand it further at their summit in Kazan, Russia in October.

That’s critical because a larger membership increases the trading zone where the currency can be used. Non-BRICS members can also agree to accept the new BRICS currency if they wish.

If you receive the BRICS currency in trade, it’s more useful if you can spend it or invest it in 20 or 30 other countries rather than just one trading partner as is the case with rubles, yuan and rupees.

This process of expanding the currency zone with new members will take a few more years, but the infrastructure is being put in place now. The development of the euro (which took eight years from the 1992 Maastricht Treaty to launch in 2000) is a good model for this.

The Great Leap to Reserve Status

While a BRICS currency will be used in trade in a few years, it will take longer to develop as a reserve currency. That requires the creation of a large, liquid bond market, which takes a legal code, issuers, dealers, settlement channels, hedging tools and much more. That process can take 10 years or longer.

What we should expect is not a sudden collapse of the U.S. dollar and the U.S. Treasury market in payments and reserves, but rather a slow, steady diminution in the role of the dollar similar to what happened with sterling after World War I.

In the short run, the main alternative to the U.S. dollar in reserve positions is not another currency, but gold. Central banks have been net purchasers of gold since 2010, reversing their status as net sellers that had prevailed since 1970.

These net purchases of gold are reflected in increases in gold as a percentage of total reserves. Gold now represents over 70% of U.S. reserves, 25% of Russian reserves and 8% of Chinese reserves.

Curiously, gold isn’t even reported in the IMF’s official reserve asset reports, despite the fact that the IMF itself owns over 1,000 metric tonnes of gold. Gold has the added attraction of being a physical, non-digital asset that cannot be frozen or seized by the United States.

The Weaponized Dollar

The most conspicuous example of financialization is the use of financial sanctions in warfare. This might better be called the weaponization of the dollar. U.S. sanctions against Russia have failed badly (as I predicted in 2022) to the point that the Russian economy is now outperforming the U.S. economy by every important metric. The U.S. hasn’t learned its lesson and is moving to more dangerous methods.

The U.S. froze Russian assets (about $300 billion in U.S. Treasury securities) at the start of the war in Ukraine. Now the U.S. is moving to steal those assets. This plan was recently unveiled on June 13 at the G7 summit in Apulia, Italy.

Russia will retaliate by seizing over $300 billion of Western assets still in Russia. Since the Russian assets are mostly in custody at Euroclear (about $200 billion), Russia can sue Euroclear for wrongful conversion in Russia-friendly jurisdictions where Euroclear has offices including Dubai and Hong Kong.

Euroclear has about $40 trillion in assets under custody. With a court judgment in hand, Russia could proceed to freeze and seize Euroclear assets on a global basis. This could throw the global financial system into complete chaos.

Financialization in its many forms is no longer a sideshow. It has become the main event in many arenas. Investors need to follow developments closely in order not to get caught in the political and military crossfire.

You need to take cover.

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