On Monday we woke up to a devalued Yuan as the USD/CNY broke through the 7 threshold for the first time since 2008. Naturally, this caused the Dow Jones to drop 767 Points as speculators and jittery investors try to make sense of all the rapidly changing events. The main event is just another round of tit-for-tat between Trump and Xi Jinping.
Nobody’s winning yet, but the unintended consequences are mounting. The tariff war has now morphed into a currency war. It remains to be seen if the eventual benefits will be worth the collateral economic damage. Unseen are the great macroeconomic forces this could put into play that will affect Main Street.
The Xi administration apparently weakened by Trump’s tariff war, took the drastic step of devaluing China’s currency in order to compete and continue to sell more goods. The Yuan has lost 5% since February. To stay competitive, Asian countries will likely follow by weakening their currencies. It’s the unintended consequences and macroeconomic spill over this could have on Americans and our families that interest me. Most importantly, will this phase of the currency war be the catalyst to pop the biggest debt bubble in mankind’s history?
Debt Bubble on Shaky Ground
With the U.S. and world debt marching to unfathomable heights and interest rates now moving back down, there is a real possibility that the Fed will not have the tools to handle the next crisis when (not if) this colossal bubble pops concurrent with other crises. Currency wars are bad, but epic debt collapses are far worse.
America’s government and citizens’ debt burdens are unsustainable. Even if some of it can be repaid, defaults on a very large portion are unavoidable. Many lenders (banks, governments, corporations) will not get paid when the debt party comes to a screeching halt. Corporate debt ($10 trillion), consumer debt ($4 trillion), student debt ($1.6 trillion; source: Fed), and the granddaddy of them all, Uncle Sam’s debt ($22.5 trillion), now total over $38 trillion!
Once again, much of this debt has a higher rating than it should have. Over the next few years, as debt becomes a headline issue and our unfunded liabilities ($210 trillion) become a major flashpoint, the next domino effect I believe will be the depreciation of the U.S. dollar. But that will not be enough. A debt jubilee where some debt is forgiven will be needed as the debt crisis unfolds.
Surprise: Quantitative Easing Ahead
I had the privilege to sit next to Paul Volcker one night for dinner when the debt was half of what it is today. I asked him if the debt ever kept him up at night? He replied, “Jen, I’ve never, ever spent even one sleepless night worrying about that.” I sat silent and dumbfounded for a few minutes as I ate my food. I then asked the former Fed Chairman, “Is that because you had a printing press?” He smiled, seemingly pleased at my perception and answered, “Exactly!”
Surprise, surprise—the printing press (or QE) will continue. Faced with defaulting or printing, they will print. How much money can the Fed print before it destabilizes the dollar? That’s the multi-trillion-dollar question.
The Slow Demise of the Dollar Against Gold
Yes I know, King USD cannot easily be dethroned; and the Euro, Swiss Franc or SDRs are not a viable replacement. For now, thanks to our relationship with Saudia Arabia, our petrodollar still insures the USD will remain a major reserve currency for a while longer, but only for as long as the Saudis keep their end of the bargain and as long as our currency is trusted and holds its value. That trust could erode quickly if the Fed is caught in a hard squeeze with nowhere to go but to the printing press. QE has not destabilized the USD yet, but there is no assurance it will not collapse under increasingly toxic future conditions.
Adding further pressure on the USD (and animosity from U.S. policymakers), more and more countries are joining Venezuela, Sudan, Cuba, Iran, Russia, India, Turkey and now China is choosing not to trade oil (and other commodities) in USD and to move away from the USD as the reserve currency.
All oil previously traded in USD thanks to our deal with Saudi Arabia. That is no longer the case as countries choose to bypass the USD and trade directly using their own currency. Russia has cut its USD trade in half and plans to reduce more. Economic warfare is unfolding as China moves to trade oil in Yuan. China is opening up its borders to oil companies without forcing them to take Chinese partners. So, we can reasonably expect China's oil production will go up, not down.
On November 12th, 2018 in Dubai, during an interview with CNBC, I recommended buying gold at $1,201.30 an ounce. As of Thursday, it’s up 24% since my recommendation. Thursday's gold price closed at $1497.40, hitting a six-year high in many currencies. Gold's all-time high of $1,917.90 was on August 23, 2011. It won't be a straight line, but I expect we will see gold push well past these highs over the next few years.
Easy Money = Debt Escalation
Agustin Carstens at the Bank of International Settlements recently said, “Monetary policy cannot be the engine of higher sustainable growth.”
As the coming debt crisis deepens and currencies fall, a light bulb will go off for those who called gold and silver a useless relic. It does its job of storing value as it has for thousands of years. Paper currency does not.
Another unintended consequence of this short-sighted war will be a devastating blow to America's farmers now that Chinese imports have fallen off a cliff. Americans can expect cheaper prices at the grocery store for soybeans, pork, wheat and cotton because of the oversupply. Tariffs are also seriously hitting the earnings of multinational corporations.
China’s stock market is also suffering. Faced with multiple large emerging challenges after nine weeks of protest, Chinese President Xi Jinping needs to decide whether to back down and compromise or stand his ground on the protests in Hong Kong. China's most powerful leader in decades will not want to lose face and look weak to the world while simultaneously playing trade war chess with Trump. The world is watching.
In addition to all the ongoing pain and suffering these trade wars are causing, goods from China are very hard to regulate because manufacturers are often one step ahead, sending goods to numerous nearby countries for assembly and re-export to America. It’s impossible to police millions of cargo containers from over a dozen proxy countries. As a result, many Chinese products will bypass Trump's tariffs. It’s hard to imagine a winner in this trade war. Before the damage becomes irreversible, let’s hope our political leaders can come to the table with win-win solutions.
With two of the world’s most powerful political figures locking horns on multiple fronts, and with the biggest debt bubble in world history ballooning to epic proportions, holding gold as a longer-term play sure seems like a good idea to me.
Disclosure: I am/we are long GOLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.