Pulling the anchor in uncharted waters

  • Ground zero
  • The US dollar will die with a whimper, not a bang
  • Follow the golden thread

What do Mexico, China and Germany all have in common?

Not much, on the face of it. Politically and culturally, it’s hard to imagine three more disparate nations. Yet all three find themselves in the crosshairs of Donald Trump’s looming global trade war.

‘US eyes tax on trade deficit countries’, reads the headline in today’s Australian Financial Review:

The Trump White House favours a “flexible” border adjustment tax targeting countries with which the US runs big trade deficits, including Mexico, China and Germany.

According to the article, Australia’s trade deficit with the US amounts to ‘only’ $25 billion. That may make us a low-priority target for retaliatory actions. But make no mistake. If the new US administration is willing to go head to head with China, Germany and Mexico to claw back every cent they can for their own coffers, it’s unlikely Australia will remain off their radar for long.

More on that in a tick. First, a look at the markets.

Markets

Overnight, the Dow Jones Industrial Average closed down by 7.13 points, or 0.04%.

The S&P 500 fell 1.99 points, or 0.09%.

In Europe, the Euro Stoxx 50 index lost 15.80 points, for a 0.48% fall. Meanwhile, the FTSE 100 was up 0.32%, and Germany’s DAX index dropped 0.29%.

In Asian markets, Japan’s Nikkei 225 index is down 114.12 points, or 0.58%. China’s CSI 300 is up 12.06, for a 0.36% gain.

In Australia, the S&P/ASX 200 index is down 46.40 points, or 0.81%.

On the commodities markets, West Texas Intermediate crude oil is US$52.91 per barrel. Brent crude is US$55.26 per barrel.

Gold is trading for US$1,193.75 (AU$1,581.36) per troy ounce. Silver is US$17.13 (AU$22.69) per troy ounce.

The Aussie dollar is worth 75.51 US cents.

Ground zero

Trade war…currency war…call it what you will.

Even if Australia manages to escape punitive new US tariffs, China is ground zero in this battle. And any damage to China’s economic output will do more than simply trickle Down Under. I’d expect more of a torrent.

It’s precisely this sort of economic warfare that inspired Jim Rickards to launch Currency Wars Trader over in the US. And it’s why we, at Port Phillip Publishing, adapted his premium service for our Australian readers — to give you a unique insight into what’s happening behind the scenes in Washington DC, and prepare your portfolio accordingly.

How can you do that?

By taking the correct position — long or short — on individual stocks, global indices, commodities, and currencies. That’s where our in-house editor and analyst come in. They provide subscribers with at least two new trades each month to buy the predicted upswings…or sell the downswings.

With the warning shots in 2017’s trade wars likely to turn to live fire sooner than later, I urge you to check out Currency Wars Trader today. You can do so here.

That’s all from me today. Read on for a guest essay from Jim Rickards himself, where he explains why the recent US dollar bull run is destined to turn around.

Cheers,
Bernd

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The US Dollar Will Die With a Whimper, Not a Bang
Jim Rickards, Strategist, Currency Wars Trader

The same force that made the dollar the world’s reserve currency is working to dethrone it.

July 22, 1944, marked the official conclusion of the Bretton Woods Conference in New Hampshire. 

It was at Bretton Woods that the dollar was officially designated the world’s leading reserve currency — a position that it still holds today. Under the Bretton Woods system, all major currencies were pegged to the dollar at a fixed exchange rate. The dollar itself was pegged to gold at the rate of $35 per ounce. Indirectly, the other currencies had a fixed gold value because of their peg to the dollar.

Other currencies could devalue against the dollar, and therefore against gold, if they received permission from the International Monetary Fund (IMF). However, the dollar could not devalue, at least in theory. It was the keystone of the entire system — intended to be permanently anchored to gold.

From 1950–1970 the Bretton Woods system worked fairly well. Trading partners of the US who earned dollars could cash those dollars into the US Treasury and be paid in gold at the fixed rate.

In 1950, the US had about 20,000 tons of gold. By 1970, that amount had been reduced to about 9,000 tons. The 11,000-ton decline went to US trading partners, primarily Germany, France and Italy, who earned dollars and cashed them in for gold.

The UK pound sterling had previously held the dominant reserve currency role starting in 1816, following the end of the Napoleonic Wars and the official adoption of the gold standard by the UK. Many observers assume the 1944 Bretton Woods conference was the moment the US dollar replaced sterling as the world’s leading reserve currency. 

In fact, that replacement of sterling by the dollar as the world’s leading reserve currency was a process that took 30 years, from 1914 to 1944.

The real turning point was the period July–November 1914, when a financial panic caused by the start of the First World War led to the closures of the London and New York stock exchanges and a mad scramble around the world to obtain gold to meet financial obligations. 

At first, the United States was acutely short of gold. The New York Stock Exchange was closed so that Europeans could not sell US stocks and convert the dollar sales proceeds into gold.

But within a few months, massive US exports of cotton and other agricultural produce to the UK produced huge trade surpluses. Gold began to flow the other way, from Europe back to the US. Wall Street banks began to underwrite massive war loans for the UK and France. 

By the end of the First World War, the US had emerged as both a major creditor nation and a major gold power. The dollar’s percentage of total global reserves began to soar.

Scholar Barry Eichengreen has documented how the dollar and sterling seesawed over the 20 years following the First World War, with one taking the lead from the other as the leading reserve currency and in turn giving back the lead. In fact, the period from 1919–1939 was really one in which the world had two major reserve currencies — dollars and sterling — operating side by side.

Finally, in 1939, England suspended gold shipments in order to fight the Second World War, and the role of sterling as a reliable store of value was greatly diminished, apart from the UK’s special trading zone of Australia, Canada and other Commonwealth nations. The 1944 Bretton Woods conference was merely recognition of a process of dollar reserve dominance that had started in 1914.

The significance of the process by which the dollar replaced sterling over a 30-year period has huge implications for you today. Slippage in the dollar’s role as the leading global reserve currency is not necessarily something that would happen overnight, but is more likely to be a slow, steady process.

Follow the golden thread

Signs of this are already visible. In 2000, dollar assets were about 70% of global reserves. Today, the comparable figure is about 62%. If this trend continues, you could easily see the dollar fall below 50% in the not-too-distant future.

It is equally obvious that a major creditor nation is emerging to challenge the US today, just as the US emerged to challenge the UK in 1914. That power is China. The US had massive gold inflows from 1914–1944. Although China’s gold purchases may have fallen off recently, it has been experiencing massive gold inflows.

Gold reserves at the People’s Bank of China (PBOC) increased to 1,842 tonnes at the end of 2016, according to the China Gold Association. That’s up 11% from the 1,658 tonnes it held in June 2015.

But China has acquired thousands of metric tonnes since without reporting these acquisitions to the IMF or the World Gold Council.

Based on available data on imports and the output of Chinese mines, actual Chinese government and private gold holdings are likely much higher. It’s hard to pinpoint because China operates through secret channels, and does not officially report its gold holdings except at rare intervals.

China’s gold acquisition is not the result of a formal gold standard, but is happening by stealth acquisitions on the market. They’re using intelligence and military assets, covert operations and market manipulation. But the result is the same. Gold’s been flowing to China in recent years, just as gold flowed to the US before Bretton Woods.

China is not alone in its efforts to achieve creditor status and to acquire gold. Russia has greatly increased its gold reserves over the past several years and has little external debt. The move to accumulate gold in Russia is no secret, and as Putin adviser Sergey Glazyev told Russian Insider in April 2016, ‘The ruble is the most gold-backed currency in the world.

Iran has also imported massive amounts of gold, mostly through Turkey and Dubai, although no one knows the exact amount, because Iranian gold imports are a state secret.

Other countries, including BRICS members Brazil, India and South Africa, have joined Russia and China to build institutions that could replace the balance of payments lending of the International Monetary Fund (IMF) and the development lending of the World Bank. All of these countries are clear about their desire to break free of US-dollar dominance.

Sterling faced a single rival in 1914, the US dollar. Today, the dollar faces a host of rivals. In addition, there is the world super-money, the special drawing right (SDR), which I expect will also be used to diminish the role of the dollar. The US is playing into the hands of these rivals by running trade deficits, budget deficits and a huge external debt.

The decline of the dollar as a reserve currency started in 2000 with the advent of the euro and accelerated in 2010 with the beginning of a new currency war. 

In his 1925 poem The Hollow Men, TS Eliot writes: ‘This is the way the world ends/ Not with a bang but a whimper.’ Those waiting for a sudden, spontaneous collapse of the dollar may be missing out on the dollar’s less dramatic, but equally important slow, steady decline. 

The dollar collapse has already begun. The time to acquire inflation insurance is now.

Regards,
Jim Rickards