The Time for Diversification Away from the Dollar Is Upon Us

The report yesterday in the UK's Independent newspaper by Robert Fisk triggered several slightly bizarre reactions which ranged from brandishing the respected reporter as a conspiracy nut to dismissing the allegations as not very useful since Mr. Fisk is not by training an economist. (Actually I would have thought that was to his credit).

What was questionable about the Independent article was the emphasis that was placed on the notion that pricing oil in another currency than U.S. dollars was really the thin end of the wedge which will lead to a phasing out of the greenback's role as the global reserve currency.

The problem with that part of the story is that it was not news, and nor does the pricing of oil really address the core issue which is the appetite that foreigners will have for dollar denominated securities, and in particular U.S. Treasuries. I have expressed views on the unsettling implications of relying solely on the U.S. dollar as the global reserve currency several times before including here, in this article , and also here.

As is often the case the Daily Telegraph's Ambrose Evans Pritchard has a good piece on the issue.

Beijing does not need to raise money abroad since it has $2 trillion (£1.26 trillion) in reserves. The sole purpose is to prepare the way for the emergence of the yuan as a full-fledged global currency.

"It's the tolling of the bell," said Michael Power from Investec Asset Management. "We are only beginning to grasp the enormity and historical significance of what has happened."

It is this shift in China and other parts of rising Asia and Latin America that threatens dollar domination, not the pricing of oil contracts. The markets were rattled yesterday by reports – since denied – that China, France, Japan, Russia, and Gulf states were plotting to replace the Greenback as the currency for commodity sales, but it makes little difference whether crude is sold in dollars, euros, or Venetian Ducats.

What matters is where OPEC oil producers and rising export powers choose to invest their surpluses. If they cease to rotate this wealth into US Treasuries, mortgage bonds, and other US assets, the dollar must weaken over time.

"Everybody in the world is massively overweight the U.S. dollar," said David Bloom, currency chief at HSBC. "As they invest a little here and little there in other currencies, or gold, it slowly erodes the dollar. It is like sterling after World War One. Everybody can see it's happening."

What I find most unsettling about the way in which many pundits continue to dismiss the de facto decline in confidence in the U.S. dollar is the the highly complacent notion that policy making with respect to the state of the U.S. public finances is fundamentally a domestic, Washington-based matter. Until the global financial system has moved further along the path of diversifying itself away from dependence on a single reserve currency, the trillions of dollar which are piling up on the public balance sheet in the U.S. are not issues which can be decided upon by interest groups, politicians and a central bank in Washington acting only with regard to their domestic agenda.

A crisis in confidence in U.S. government securities, brought on by the ongoing attrition in the dollar as a store of value, would lead to an avalanche of liquidations which would completely overshadow the near meltdown of last October.

In the dire circumstance where there is a serious questioning as to whether to continue to prop up an asset class which has passed its "sell-by" date, cleverly chosen phrases from Messrs. Bernanke and Obama about further guarantees, underwritten by U.S. taxpayers, would be unlikely to restore calm and appease anxious foreign sellers of U.S. securities.

The time to move forward on further reserve currency diversification is sooner rather than later and the gold market is now sending that message loudly and clearly.

Comments

[TradingHelp...:]

As an investor you wouldn't put all your money in one asset: silver, Aussie dollars, $GOOG would you?

So it's totally illogical that the USD is the only reserve currency.

Diversification doesn't just make theoretical sense it's a must.

The question is what should the other reserve option be? Gold, JPY, CHF?

I don't know the answer but I know putting all your eggs in one basket, even the USD, goes against everything we have been taught as investment professionals.

Oct 07 06:35 AM

[Moon Kil Woong:]

The slow movement of US policy will not determine the plight of the US dollar. It is being driven by a marked lack of US Treasury demand due to a laxidasical Federal Reserve that has stooped so low as to try fixing their own Treasury auctions rather than adjusting them to the interest rates that are requisite to sell the amount of bonds they wish to sell.

It should be unsettling to all. I am sure the founding fathers would cringe at the powers of the Federal Reserve to depriciate without representation. Certainly the result is not just the same but worse as taxation. For it destroys the value of our assets by destroying the value of the US dollar. This amounts to takings.

The founding fathers were careful even not to give Congress this power. Accordingly, the government only has the rights to tax you on what you make (although this has been eroded) not what you already have.

In effect the Federal Reserve is increasingly putting the US in an untenable position of deciding to either accept a depression to save the dollar or accept letting the dollar drop to nothing in which your assets go up in smoke, thereby lettting the banks seize most everything through forclosure and collections. Both these futures merely shift hard assets to banks at the expense of everyone else.

Even gold is not safe in these scenarios. In a depression money becomes king and as long as you have debt you must sell any asset to settle the debt (at a very low price). In a inflationary environment, all you do is protect the asset value you have against inflation. You don't actually benefit. and you must pay for your synthetic capital gains when you sell even though they are only the synthetic results of currency depreciation.

Thus the only real solution is to demand that the Federal Reserve ceases or stops it's persistent campaign at currency devaluation and that the US government ceases to run deficits when there is no recession or depression. Only then can we hope to right this ship of state.

Oct 07 07:38 AM

[Clive Corcoran:]

Moon

I agree entirely with your conclusion i.e. "the only real solution is to demand that the Federal Reserve ceases or stops it's persistent campaign at currency devaluation and that the US government ceases to run deficits when there is no recession or depression"

The trouble is that the Fed, and the other powers that be, don't listen to demands - they only pay attention when matters become super-critical

Oct 07 07:51 AM

[Mad Hedge F...:]

brt Of course you knew it was going to happen like this. After churning around just below the old high, and sucking in as many profit takers and short sellers as possible, gold blasted through to a new high for the year of $1,038. Never mind that the triggering event is complete balderdash, a story in Britain’s Independent newspaper asserting that the Middle East is holding secret global talks to price crude in the yellow metal or other currencies (click here ). It didn’t hurt that Australia cut its interest rates by 0.25%, the first G-20 country to do so. There probably isn’t enough gold in the world to finance more than a few weeks of global oil production. Total gold holdings would only fill two Olympic sized swimming pools. But never let the truth get in the way of a good trade. The confirming moves couldn’t be more ubiquitous, with the Canadian, New Zealand, and Australian dollars all up big, commodities strong, and silver also going ballistic. Regular readers will all recognize these as old friends of mine, core longs that I have been strongly recommending since the beginning of the year. I have been trying to get investors into gold since it was at $800. If you aren’t in gold by now, I can only tear my own clothes and flagellate myself for my abject failure to convince you of gold’s merits. US government debt is exploding, and with foreigners holding a large part of our paper, the only way to get out of this mess is to devalue the dollar. It’s like Obama invited China’s president Hu Jintao to dinner at an expensive Upper East Side restaurant, fakes a sudden case of food poisoning, leaving him with a big fat bill. Next stop $1,200, then $1,500, then the old inflation adjusted high of $2,400. If you want me to help you get set up to trade futures in any of this stuff, please email me at madhedgefundtrader@yah... If you want to know where to buy physical gold and silver in size, or coins with the tightest spreads over spot, check with the experts at www.millenniummetals.net by clicking here.

Oct 07 08:09 AM

[Michael Clark:]

The Fed's loyalty is to the banks, not to the citizens of America. We've given them power over us because they were going to make us all obscenely RICH. That was a nice dream, wasn't it? Now, back to your regular scheduled programming.

Oct 07 08:12 AM

[Michael Clark:]

"Thus the only real solution is to demand that the Federal Reserve ceases or stops it's persistent campaign at currency devaluation and that the US government ceases to run deficits when there is no recession or depression. Only then can we hope to right this ship of state. "

I agree, Moon We need to learn discipline. We need to stop being self-indulgent children about life and take a deep breath and realize that it's time to grow up and start saying 'No" to ourself, 'No' to our needs and pleasures. There is a time for these things -- but 'self indulgence' means than one clings to his pleasures even when the time for the end of those indulgences has passed.

We need to face the truth and adjust ourselves to a new reality. To do this, we need our leaders in Washington and New York to start telling us the truth for a change.

Oct 07 08:22 AM

[James Lewis:]

Lets trade oil in chinese RMB then.
Oh that won't work, the RMB can only be purchased in airports at 7% below its value.

Better still lets trade in oil, everytime you want some petrol; you have to bring some gold bullion to the petrol station. But make sure you cut the right weight.

That's it - the Russian Ruble. Open, politically secure, trusted currency from an open, trusted government.

O.K. O.K - I get it, lets trade oil in the Japanese Yen. Because the Japanese haven't had/do not have any system problems. And their banking system has not been bankcrupt/is bankcrupt for the last 20 years.

Sorry for being dumb - lets price it in a basket of the above currencies. This will help to diverisfy risk, because 4 bad currencies is better than 1.

- Absolute madness -

Oct 07 11:54 AM

[User 387760:]

The above article and following comments are considered, but there is, I submit, something askew with the perspective.

Investors and adivosrs think in terms of assets and circumstances that affect the assets, in the sense that sometimes you buy, sometimes you don't, depending what is being done to the asset. Writers talk about the dollar as though it is an object of investment strategy.

This is not wrong, per se, but one should back away and look around. We are discussing how to play Monopoly when the house we are in is about to fall.

To have the dollar a universally used currency medium is a good thing for us as people, especially where the dollar has no intrinsic value - being, essentially Monopoly money, the way our Keynesian preppies wanted it.

Put aside your future's logic for investing in a money. When the dollar is rejected, as probably happened already, the after-shock is going to be a cruel awakening for the average person as their holding will lose purchasing value.

Those in the know, can make more paper money during the collapse, but remember that the entire Keynesian game is the problem and being good at playing it makes things worse. This is because the game is coming to an end. Keynesians do not comprehend an end to the ponzi scheme, but paper is paper.

I suppose what I am saying is we should focus less on playing a game with the paper ponzi scheme and prepare ourselves, clients, friends, and family for what is to come. Here, investment acuity can provide actual protection, not just provide the next best investment strategy.

Oct 07 12:23 PM

[Catfish:]

As any fool will plainly see, I am not an economic intellectual. But I do pretend to understand what has been cited in previous blogs.

What I want to know is, where is a safe haven for my money? Canada? Australia? Zimbabwe? Well, right now we are looking at a Zimbabwe type economy.......well, potentially.

I've been thinking about buying (converting) to Aussie bucks. Is this a good thing?

Oct 07 02:53 PM

[Joe Duggins:]

The Federal Reserve estimates that in the past year losses in real estate, stocks and mortgages have sucked out some $7.2 trillion of wealth from the U.S. economy. Some are now putting the figure at $20 trillion.Investors should also especially be concerned as to who will repay these massive debts. The conventional answer of politicians is “taxpayers”. But this is a serious understatement. Any depreciation of the U.S. dollar means that every American citizen and every single holder of U.S. dollars throughout the world will suffer from monetary loss and a severely reduced standard of living.

When the USD is devalued, foreign countries have to decide : devalue their own currencies or they will not be competitive against America. Imagine if USD is devalued 75% against Oil, it means that cost in USD will be a lot cheaper by up to 75%. Countries will embark on competitive devaluation or they will be priced out of economic competitiveness.
----------------------...
Money without intelligence is like a car without a road.
www.intelligentinvesti...

Oct 07 05:17 PM

[Tony Daltorio:]

No, the madness is selling a valuable asset - oil - in return for pieces of 'toilet paper' issued by the Fed, especially when the Fed and US politicians have basically told you that their goal is to make those pieces of 'toilet paper' worthless.


On Oct 07 11:54 AM James Lewis wrote:

> Lets trade oil in chinese RMB then.
> Oh that won't work, the RMB can only be purchased in airports at
> 7% below its value.
>
> Better still lets trade in oil, everytime you want some petrol; you
> have to bring some gold bullion to the petrol station. But make sure
> you cut the right weight.
>
> That's it - the Russian Ruble. Open, politically secure, trusted
> currency from an open, trusted government.
>
> O.K. O.K - I get it, lets trade oil in the Japanese Yen. Because
> the Japanese haven't had/do not have any system problems. And their
> banking system has not been bankcrupt/is bankcrupt for the last 20
> years.
>
> Sorry for being dumb - lets price it in a basket of the above currencies.
> This will help to diverisfy risk, because 4 bad currencies is better
> than 1.
>
> - Absolute madness -

Oct 07 05:59 PM

[Zmartmoney:]

Oh Great! We can be highly competitive paupers...all looking for jobs in manufacturing (?) and mining (?) and...


On Oct 07 05:17 PM Joe Duggins wrote:
> When the USD is devalued, foreign countries have to decide : devalue
> their own currencies or they will not be competitive against America.
> Imagine if USD is devalued 75% against Oil, it means that cost in
> USD will be a lot cheaper by up to 75%. Countries will embark on
> competitive devaluation or they will be priced out of economic competitiveness.

Oct 07 06:55 PM

[E Nuff Sed:]

Catfish,
The best assets you can buy now is a diversified basket of stable safe low leverage dividend paying stocks with great track record.
Follow Dividend4life. He will make you a lot of money.
seekingalpha.com/artic....
These are global companies with wide moats and Darwinian survivors which return money to investors.

Oct 07 07:06 PM

[Zouk_man:]

Perhaps the whole thing needs to crash and burn so we learn the lesson to stop sending the same people back to Washington to play the same con game over and over. We are smart enough to know better.

Decades of chasing away manufacturing. Importing everything we used to make. High taxes for the socialist state. Printing presses for foreign policy. Our fault for not standing up to this charade long ago. I hope the dollar caves like a broken ship to the bottom of the sea. It will be a painful process, but perhaps a better America will be the result.

Long Oil, Gold, Foreign Currencies, and the Constitution.

Oct 07 07:25 PM

[Mitul Kotecha:]

A lot of the issues brought up in the above mentioned UK Independent newspaper article and the many other similar articles predicting the demise of the dollar are structural in nature ie long term diversification away from the USD.

The reality is that diversification has been ongoing for years (just take a look at the IMF Cofer data). The dollar is still the dominant currency in global FX reserves even if its dominance is being gradually eroded.

One thing to consider is that during this structural dollar decline the dollar has managed some fairly sizeable cyclical upswings. At present, low US interest rates and a worsening interest rate differential with other countries (even the Japanese yen has benefited from the interest rate differential) means the downward cyclical pressure on the dollar is going to continue until the market starts to become more aggressive in pricing in US interest rate hikes.

Eventually Fed policy will turn and when markets price this in suddenly the dollar will not look so bad from a cyclical perspective even it still faces a long term structural decline.

Oct 08 05:39 AM

[Clive Corcoran:]

The comments raised are, in some cases, more apocalyptic than was the intention of the article. We may be heading for a dollar crisis but only if the powers that be are not smart enough to harness the possibilities for a transition to a better framework for international settlements for both trade and capital movements rather than relying effectively on a dollar standard

Mitul,

The point I was really making was echoed by another contributor in a piece today by John Browne also reprinted at Seeking Alpha

"Although a nation whose currency enjoys reserve status is given a great many advantages, the privilege does come with responsibility."

Below is a comment to that sentence with which I am in total agreement:

It is the sense that the US has abdicated its responsibility with respect to being the custodian of the reserve currency, in order to look after its internal agenda, which is driving the move towards another - more diversified - model for international settlements

Oct 08 12:26 PM

[Michael Clark:]

Clive:

Are you saying the world has lost faith in Bernanke? A lot of us in America have also lost faith in Bernanke. How do we get rid of him?


On Oct 08 12:26 PM Clive Corcoran wrote:


> It is the sense that the US has abdicated its responsibility with
> respect to being the custodian of the reserve currency, in order
> to look after its internal agenda, which is driving the move towards
> another - more diversified - model for international settlements

Oct 08 12:32 PM

[morph366:]

Michael,

Sad to say but I think the world is losing faith in Washington DC and Wall Street

Oct 08 12:52 PM