China attacks the dollar, again.
Last year Chinese Yuan (currency of 2nd biggest economy in the world) was formally added to the SDR basket – an international currency issued by the IMF. The set time of 12 months was agreed upon and time flies quickly, and on 30th September Yuan will be officially part of SDR.
ValueWalk's Raul Panganiban with Maurits Pot, Founder and CEO of Dawn Global. Before this he was Partner at Kingsway Capital, a frontier market specialist with over 2 billion AUM. In the interview, we discuss his approach to investing and why investors should look into frontier and emerging markets. Q2 2021 hedge fund letters, conferences and Read More
Chinese are not sitting on their hands. They do whatever they can to make their own currency and the SDR popular in international trade simultaneously diminishing the role of USD. Recently the World Bank announced for the first time in history they are going to issue SDR-denominated bonds. The buyer – Chinese, no surprise here, and to be precise the Asian Infrastructure Investment Bank, the Asian Development Bank and few commercial banks.
This is important because the World Bank does not need money as it is one of the most capitalised institutions in the world. China asked for those bonds to increase international exposure of the SDR. This is a precedent and a very clear message to the biggest players out there: “from now on, put your capital surplus into SDRs to limit your exchange-rate risk.” Additionally, thanks to this agreement with the World Bank, Beijing will be able to diversify their dollar reserves and popularise the use of a common currency they are a part of. The sum we are talking here is only 2 bn SDR (~2.8 bn USD) but in practice, it is a big step forward enabling further SDR-denominated sales.
Another move came from the International Monetary Fund after they published their report giving guidelines on how to issue a corporate debt denominated in SDR. In the beginning, public investment funds from Singapore, Norway or Denmark will acquire debt in this international currency. Later smaller investors will be allowed to participate.
The scale of the latest changes is significant. Today, 23 countries prepared USD-SDR swap lines. Countries like China, Russia and France officially pointed towards replacing the dollar system with international currency.
During the G20 summit on 4th September details of the process of smooth conversion of USD debt into SDR debt should be clarified. Hosting it in the Chinese city of Hangzhou was not a coincidence as Asian culture pays attention to details and symbols.
To kill speculations we have to point out that any form of transition from the system based on USD to SDR one is not going to happen overnight. In order for the currency, administered by the IMF or the World Bank, to be used widely by central banks it needs a certain level of liquidity in the first place.
The dollar is a reserve currency due to vast liquidity and its popularity. Without any problem you can purchase bonds with terms from 30 days to 30 years. This is far from being the SDR case but this is only a question of time.
To answer this question, let us move back in time. In 1969 when elites were afraid of the fall of USD they created the SDR. The Vietnam War and the Great Society were funded through a drastic increase in dollar supply. The whole world understood the gravity of this action and many countries started to exchange their dollars for gold and this led the US gold reserves to drop from 20 000 to 10 000 tonne. This metal drain was stopped by Nixon in 1971 but problems of the USD had just begun.
A few years later dollar experienced a crash, a jump in commodity prices (oil crisis) and the beginning of hyperinflation in the US. The trust given to dollar fell so hard that in 1977 Washington had to borrow money in CHF. There was no demand for US bonds sold in dollars. To save the day and finish the crisis of trust and lack of liquidity, SDRs were issued in dozen rounds by the IMF and this brought back stability.
Between 1980 and 2008 we can see a period of relative peace and USD domination. After Lehman fell the situation slowly started to change when central banks all over the world began to buy junk debts to save the system. It was 2008 when for the first time in 30 years the IMF sold 100 bn USD worth of assets in SDR. Reason? Officially, central banks were not able to secure enough liquidity for the financial market.
We can perceive it as a test which checked whether we were able to advance the control over the monetary system to another level. Today, central banks’ balance sheets are full of toxic assets, liquidity is very low. Everything caused by the very banks themselves. One has to be naïve to believe that the same people who created the problem can solve it.
If central banks did the only thing they were created for in 2008 rather than intervene, we could be already after a massive wave of bankruptcies of badly governed institutions. Investors making bad decisions and taking too much risk would have paid for that in debt write offs. In just few months the situation would be cleansed and economies could finally base their growth on a solid foundation. Instead, we experienced central banks kicking the can down the road and only increasing the scale of potential consequences. The result? A salvation is said to come through the SDR, but what is it?
The SDR is nothing more than an artificial currency and a mix of the exchange rate of:
– USD – the reserve currency the whole world starts to leave behind, issued by a country with 1 trillion USD deficit.
– EUR – the currency of artificial creation, the EU, with life support of 80 billion EUR printed each month.
– GBP – former reserve currency falling in the ranking each year. The UK’s lack of decent gold reserves that could restore faith in the currency is definitely an issue.
– JPY – the obvious winner of currency wars. The leader of purchasing power destruction of Japanese people. In only few months the currency itself is said to be given out ‘for free’ only to stimulate spending and the economy. A thing that has not worked for 30 years, is not going to work this time. No matter what sort of acronym (TINA, TTID) we will come up to call the excuse. Albert Einstein had a really nice quote about insanity and it fits perfectly for central bankers.
– RMB – officially being destroyed just like the others. We do not know yet whether Beijing after period of using SDR wouldn’t want to base their currency on vast reserves of gold.
Circumstances around the SDR renaissance we see today show that it is rather a tool and not the solution. Those governing the global financial market can potentially buy some time and enable a smooth transition from petrodollar system to multipolar one.
Yuan joining the SDR basket is another nail in the coffin of the dollar. This change will not happen overnight and although, debt issued in SDR is of very small volume it can start a bigger process.
I believe that on 4th September, during the G20 summit, internationalisation of both yuan and SDR is going to pick up speed. Nonetheless, 60% of global currency reserves stored by central banks are in dollars. In case of a deep crisis of trust in the dollar, a share of debt can be converted into SDR but for now, no one seems to be ready for any instability. With current levels of debt, it is very hard to control the situation.
A few years ago the debt reset and transition towards a new system was planned. The bail-in, enabling a takeover of deposits was one of the main components. It appears that this plan is abandoned and a ‘good old’ IMF bail-out is the plan A now. When banks seize money from depositors, people turn to cash. This doesn’t help the war on cash waged by the financial elite. It is better to wait 5-10 years, remove cash and enable another level of control.
No matter which way global planners would choose, the biggest loser of the systemic changes towards the SDR is going to be American dollar. The defeat will be two-fold – in international trade (transactional currency) and the lost role of reserve currency (in central banks’ vaults).
Should we see any movements in USD charts after 4th or 30th September? I do not think so. If USD is about to have a bad time it is due during ‘after-election pre-nomination’ period. I believe this is when the FED lowers interest rates and officially returns to QE. The USD is going to lose few percent vis-à-vis other currencies. This in turn should increase prices of precious metals and commodities.
Finally, I wanted to highlight one thing. If the world accepts the SDR as new supranational currency, 189 countries (members of the IMF) are going to fall into the trap of the international finance cartel. The same way as Greeks fell into the trap of the ECB. Were it for the central bank controlled by Greeks or for the government to be responsible for issuing currency, the creditors would have already be paid back with the economy growing without undue burden of crushing debt. Now, the country is in economic and societal decay. What is worse? There seem to be no end to it.