US dollar’s grip on global markets might be over, warns Goldman

Goldman Sachs has issued a bold warning 28 July, 2020, that the dollar is in danger of losing its status as the world’s reserve currency. Goldman Sachs Group Inc has put a spotlight on the suddenly growing concern over inflation in the United States.

With the US Congress closing in on another round of fiscal stimulus to shore up the pandemic-ravaged economy, and the Federal Reserve (Fed) having already swelled its balance sheet by about $2.8 trillion this year, Goldman strategists cautioned that US policy is triggering currency “debasement fears” that could end the dollar’s reign as the dominant force in global foreign-exchange markets.

While that view is clearly still a minority one in most financial circles — and the Goldman analysts don’t say they believe it will necessarily happen — it captures a nervous vibe that has infiltrated the market this month: Investors worried that this money-printing will trigger inflation in years ahead have been bailing out of the dollar and piling furiously into gold.

Gold is the currency of last resort

“Gold is the currency of last resort, particularly in an environment like the current one where governments are debasing their fiat currencies and pushing real interest rates to all-time lows,” wrote Goldman strategists including Jeffrey Currie. There are now, they said, “real concerns around the longevity of the US dollar as a reserve currency.”

The Goldman report makes clear that Wall Street’s initial reluctance to sound the alarm on inflation back when the pandemic began is fading. Having been burned badly by ominous forecasts of runaway price gains following the fiscal and monetary stimulus that followed the 2008 financial crisis, many analysts have been hesitant to repeat such calls now, especially as the economy sinks into a deep recession.

But with gold surging to record highs and bond investors’ inflation expectations climbing almost daily, albeit from very low levels, the debate on the long-term effects of stimulus has gotten louder.

The 10-year breakeven rate, the gap between nominal and inflation-linked debt yields, has risen to about 1.51 per cent, up from as low as 0.47 per cent in March. That’s seen real yields, which strip out the impact of inflation, plunge further below zero — to about -0.93 per cent on similar-maturity bonds.

“The resulting expanded balance sheets and vast money creation spurs debasement fears,” the analysts at Goldman wrote. This creates “a greater likelihood that at some time in the future, after economic activity has normalized, there will be incentives for central banks and governments to allow inflation to drift higher to reduce the accumulated debt burden,” they said.

Gold’s record-breaking rally highlights growing concern over the world economy.

Goldman raised its 12-month forecast for gold to $2,300 an ounce from $2,000 an ounce previously. That compares with a value of around $1,950 currently. The bank sees US real interest rates continuing to drift lower, boosting gold further.

The Bloomberg Dollar Spot Index is on course for its worst July in a decade. The drop comes amid renewed calls for the dollar’s demise following a game-changing rescue package from the European Union deal, which spurred the euro and will lead to jointly issued debt.

The dollar is used in 88 per cent of all currency trades, according to the latest triennial Bank for International Settlements survey. And it still accounts for about 62 per cent of the world’s foreign-exchange reserves, although that’s down from a peak of more than 85 per cent in the 1970s, IMF data show.

Ballooning debt pile

For Goldman, the growing level of debt in the US, which now exceeds 80 per cent of the nation’s gross domestic product, and elsewhere, boosts the risk that central banks and governments may allow inflation to accelerate.

Investors are poised to hear more about the Fed’s view on inflation with its latest policy decision Wednesday.

“Until we get through the Fed, the dollar could strengthen as investors lock in profits,” Edward Moya, a senior market analyst at Oanda Corp. said in a note.

Goldman Sachs has tied the metal’s rally to a “potential shift in the US Fed towards an inflationary bias against a backdrop of rising geopolitical tensions, elevated US domestic political and social uncertainty and a second wave of COVID-19 related infection.”

“Gold is the currency of last resort, particularly in an environment like the current one where governments are debasing their fiat currencies and pushing real interest rates to all-time lows,” the bank said. “With more downside expected in US real interest rates, we are once again reiterating our long gold recommendation from March.”

Year-to-date, gold has gained more than 27 per cent and is currently trading near $1,940 an ounce.

Fed faces currency threat

Predictions of the mighty US dollar’s fall from its place as the ultimate measure of value are nothing new.

“Gold bugs” — the slightly disrespectful term for people convinced the yellow metal is the only truly safe investment — roll out an attack on the US dollar’s safety every few years.

The euro has been an aspiring candidate, but has had many troubles of its own. Countries that do not get along with the US, including Iran, have complained about the absurdity of having to sell their oil to third parties priced in US dollars.

After the global financial meltdown of 2008, China’s then central banker, Zhou Xiaochuan, criticized the use of a single country’s currency for a world standard, calling it a historical anomaly.

“The crisis again calls for creative reform of the existing international monetary system toward an international reserve currency with a stable value, rule-based issuance and manageable supply,” wrote Zhou.

But the comments from New York bankers Goldman Sachs just as gold is hitting new highs and the greenback is hitting new lows are quite different from bellyaching from those who would like to take the dollar’s place.

The Goldman comments act as a warning of what might happen if the US currency eventually becomes debased through too much government spending and too much borrowing at interest rates close to zero.

The Canadian dollar is up two cents against the US currency in the last month. But as usual, that is deceptive. With most of our trade happening with the US, the loonie tends to rise and fall with the US dollar. The loonie continues to trade lower against the euro.

The Goldman Sachs report is making lots of headlines and offers a little thrill of dread to those who are looking for an even more dire outcome from the current pandemic. But gold quite regularly rises in value during times of financial uncertainty and it tends to fall shortly after.

Russia and China speed up de-dollarisation process

After years of talking about abandoning the US dollar, Russia and China are doing it for real. In the first quarter of 2020, the share of the dollar in trade between the countries fell below 50 per cent for the first time.

Just four years ago, the greenback accounted for over 90 per cent of their currency settlements.

According to Moscow daily Izvestia, the share has dropped to 46 per cent, tumbling from 75 per cent in 2018. The 54 per cent of non-dollar trade is made up of Chinese yuan (17 per cent), the euro (30 per cent), and the Russian ruble (7 per cent).

The dollar’s reduced role in international trade can mainly be blamed on the ongoing trade war between the US and China.

In January, Russian Foreign Minister Sergey Lavrov explained that Moscow is continuing “its policy aimed at gradual de-dollarisation” and is looking to make deals in local currencies, where possible.

Lavrov called the rejection of the greenback “an objective response to the unpredictability of US economic policy and the outright abuse by Washington of the dollar’s status as a world reserve currency.”

Movement away from the dollar can also be seen in Russia’s trade with other parts of the world, such as the European Union. Since 2016, trade between Moscow and the bloc has been mainly in Euros, with its current share sitting at 46 per cent.

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