Last
week I wrote that contrary to the prevailing mood US dollar strength could
reverse at any time. This week I look at another aspect of the dollar, which
almost certainly will become a significant source of supply: a global shift
out of it by foreign holders.
As well
as multinational corporations that account in dollars, there are non-US
entities that use dollars purely for trade. And so long as governments
intervene in currency markets, governments end up with those trade dollars in
their foreign reserves. Some of these governments are now pushing hard to
replace the dollar, having seen its debasement, which is beyond their
control. This has upset nations like China, and that is before we speculate
about any geopolitical angle.
The
consequence of China's currency management has been a massive accumulation of
dollars which China cannot easily sell. All she can do is stop accumulating
them and not reinvest the proceeds from maturing Treasuries, and this has
broadly been her policy for at least the last year. So this problem has been
in the works for some time and doubtless contributed to China's determination
to reduce her dependency on the dollar. Furthermore, it is why thirteen
months ago George Osborne was summoned (that is the only word for it) to Beijing
to discuss a move to urgently develop offshore renminbi capital markets,
utilising the historic links between Hong Kong and London. Since then, it is
reported that last month over 22% of China's external trade was settled in
its own currency.
Given
the short time involved, it is clear that there is a major change happening
in cross-border trade hardly noticed by financial commentators. But this is
not all: sanctions against Russia have turned her urgently against the dollar
as well, and together with China these two nations dominate and carry with
them the bulk of Asia, representing nearly four billion rapidly
industrialising souls. To this we should add the Middle East, most of whose
oil is now exported to China, India and South-East Asia, making the petro-dollar
potentially redundant as well.
In a
dollar-centric currency system, China is restricted in what she can do,
because with nearly $4 trillion in total foreign exchange reserves she cannot
sell enough dollars to make a difference without driving the renminbi
substantially higher. In the past she has reduced her dollar balances by
selling them for other currencies, such as the euro, but she cannot rely on
the other major central banks to neutralise the market effect of her dollar
sales on her behalf. Partly for this reason China now intends to redeploy her
reserves into international investment to develop her export markets for
capital goods, as well as into major infrastructure projects, such as the
$40bn Silk Road scheme.
This
simply amounts to dispersing China's dollars into diverse hands to conceal
their disposal. Meanwhile currency markets have charged off in the opposite
direction, with the dollar's strength undermining commodity prices, most
noticeably oil, very much to China's benefit. And while the talking-heads are
debating the effect on Russia and America's shale, they are oblivious to the
potential tsunami of dollars just waiting for the opportunity to return to
the good old US of A.
