The US treasury securities are the most traded security in the world. They trade 24 hours a day, 7 days a week. The US dollar is the most frequently used currency in world global trade. From 1999 through 2019, 96% of all world trade was invoiced in US Dollars. BUT there is a movement underway to replace the dollar with a new currency. For several years, Brazil, Russia, India, China, and South Africa (BRICS) have been discussing the creation a common currency which they would use in place of the dollar. Iran and Argentina are considering opting into the group as well. Those seven countries represent about one third of all global trade.
After meeting with Vladmir Putin in Moscow, Xi Jinping met with the leaders of Uzbekistan, Kazakhstan, Kyrgyzstan, and Tajikistan, five of the six members of Shanghai Cooperation Organization (SCO). Missing from the meeting was the sixth member, Russia. The SCO has already launched some trade using local currencies in place of the US dollar, and Iran proposed launching a common currency for SOC transactions. Belarus, Bahrain, The Maldives, the United Arab Emirates, Kuwait, Myanmar, Egypt, Qater, and Saudi Arabia are also having similar discussions. The matter is complicated by the fact that these countries are major exporters of natural resources. It appears that those countries who are facing sanctions or are otherwise unhappy with the US power and dollar dominance are seeking alternatives. And the impact could have dramatic consequences.
Of course, with Congress again being asked to raise the debt ceiling, there is always a chance that the US could default if no agreement is reached. Investors need to be prepared; however, I believe that selling to cash is probably a losing strategy.
Before discussing consequences, it is worthwhile to understand how the dollar and the US treasuries became the world standard for financial transactions and reserve currency. Beginning in 1944, 730 delegates from 44 nations met for 22 days at the United Nations Monetary and Financial Conference at Bretton Woods. With the Great Depression and World War II fresh in their minds, the delegates formed the International Monetary Fund, the World Bank, and the General Agreement on Trade and Tariffs. 153 nations signed onto the agreement. The dollar emerged as the preferred currency. Prior to that meeting the British pound sterling, the French Franc, and the German Deutsch Mark were the currencies of trade.
Since then, the role of the dollar has continued to expand. The financial system was once described as a sewer which collects all financial transactions in its massive system of pipes. The center of the sewer is New York City, where every major bank in the world has an office through which transactions pass. American fund managers control 55% of the world’s assets, and the United States accounts for over 20% of world GDP. The US treasuries and dollars are backed by the full faith and credit of the United States Government.
Trade is conducted in US dollars. If trade were to be transacted in local currencies, of which there are about 150 or more, there would be over 11,750 different exchanges. There are over $4.5 trillion of contracts drawn every day, seven days a week. The volume is mind-boggling.
The present operation for trade is a delicate ecosystem which has been developing for decades, and countries like those in the BRICS nations would like to see it disrupted. China under Xi Jinping wishes to become the world leader militarily, economically, and technologically. It makes sense that they see the dominance of the US dollar as hindering that objective. Given the current attitude in Washington DC China feels like the United States is being a bully. It is no wonder China has gathered likeminded nations to explore how to replace in part or in whole the greenback.
The impact would disrupt not only the world financial system but also US markets. US treasuries are the primary security of foreign central bank reserves. Japan and China each hold about $1 trillion (3%) of US government debt. Foreign nations hold about 30% of US government debt securities, with the other 70% held by US nationals and institutions.
Imagine the upset if foreign governments began to reduce their holdings, selling $10 trillion into the market. The price of government bonds would probably plummet. We have seen treasury values tumble as a result of the Federal Reserve raising interest rates. Silicon Valley Bank is the prime example, but that example pales in comparison to what would be triggered by a massive sell off of US Treasuries by foreign governments.
Not only would foreign governments be selling, but US institutions would also likely dump their bonds as prices sank.
In all it is not a pretty picture. Whether it is gradual or more rapid, there is a significant probability the BRICS and other interested countries could make it happen. The BRICs and their collaborators have a significant incentive to follow thorough. If it does, it would probably augment current inflation to higher levels.
It goes back to our theme that “things which have never happened before happen all the time.”
Building account values over the longer term is, to my way of thinking, the best solution for countering the impact of inflation and for dealing with an alternative currency. It all will come down to longer-term performance, although there is little doubt that performance will probably come with greater volatility.
This is another of those events which does not figure into the nice financial plans most advisors lay out for their clients. Algorithms that are based on historical data cannot adapt to the evolving market because there is no comparable data. For us at AFC, we simply want to grow our client portfolios to provide an adequate margin in the event the BRICs succeed. We believe that should be the primary objective for all investors. Prepare for the worst and hope for the best.
