Central banks around the globe are ending 2021 with the highest gold holdings in 31 years.
Yet the real story as monetary authorities recalibrate foreign-exchange reserve holdings is how the US dollar is on the losing end of these shifts. And in the year ahead, this trend could become a systemic problem.
True, the dollar’s value versus gold has been falling for more than a decade now. That’s a product of ultraloose Federal Reserve policies flooding the globe with record liquidity. Now, even as the Fed moves to tighten the credit spigot a bit, other monetary powers are pivoting to gold.
The reason is growing concerns that the dollar’s reserve-currency days are over, or at best numbered.
The 30-year bookmark has become a hallmark of 2021. China’s economic growth recently dropped to the lowest levels in three decades. US inflation and Japan’s Nikkei Stock Average both surged to the highest levels since the early 1990s. But the 30-year metric that might matter most is central banks shifting from dollars to gold.
According to the World Gold Council, central bank stockpiles of the yellow metal have now increased by more than 4,500 tons over the past decade. At the end of September, such reserves totaled 36,000 tons, a level not seen since 1990.
Might all hell break loose for the dollar in 2022?
Most analysts agree the next couple of months could be kind to the dollar. The Fed’s shift toward tighter policy coincides with the People’s Bank of China pivoting toward monetary loosening.
Investment strategist Manpreet Gill at Standard Chartered Bank speaks for many when he says: “We think the dollar has room for strength at the start of the year.”
But there are at least five headwinds facing the dollar in 2022. And five reasons to worry economist Stephen Roach’s belief that “the dollar’s crash is only just beginning” are looking less hyperbolic by the day. As Roach, former chairman of Morgan Stanley Asia, asks: “Why in the world would you own dollar debt?”
Five reasons to worry
Let’s count the ways.
One: Fiscal excess runs amok. Donald Trump’s 2017-2021 presidency accelerated the surge in US debt journey toward the $30 trillion mark. President Joe Biden’s infrastructure and social-spending plans come just as US inflation skyrockets. That’s putting upward pressure on US Treasury yields.
Since the 2008 Lehman Brother crisis, global investors have become accustomed to ultralow US yields. One could say, in fact, that markets came to take dollar risks for granted. Yet US Treasury rates tend to be a one-way bet – until they’re suddenly not. As concerns about Washington’s runaway debt collide with surging inflation and a Covid-19 explosion sure to slam the economy, that moment could be soon.
Two: Stock froth is getting irrationally exuberant. It was exactly 25 years ago this month that then-Fed Chairman Alan Greenspan used these words to send a shot across the bow of stock bulls. The equity bubbles of the mid-1990s were a mere fraction of where asset markets are heading into 2022.
For many years, James Glassman and Kevin Hassett wore egg on their faces for writing “Dow 36,000” back in 1999. Yet 22 years and one pandemic later, that’s where the Dow Jones Industrial Average is ending the year. What these dreamers missed was the need for untold trillions of dollars of cash from the Fed, European Central Bank and Bank of Japan to make it happen.
Far from a milestone, the nosebleed heights US equities are at is a warning sign of trouble to come. If the Delta variant of Covid-19 didn’t slam the economy, Omicron is surely about to get the job done. Even with the US facing stagflation and the specter of fresh lockdowns, economist Edward Yardeni calculates the S&P500 is trading 22% above future earnings. Irrational indeed.
Three: the yuan has the momentum. Since June 2020, the yuan has risen more than 10% versus the dollar. It bellied Trump’s claims that China was artificially depressing exchange rates. On his way out the door in late 2020, Trump left Beijing off the US Treasury’s “currency manipulator” list, adding Vietnam instead.
Yet the move by central banks to pivot away from the dollar comes just as Chinese President Xi Jinping’s effort to internationalize the yuan gains traction.
Not everyone agrees with billionaire hedge fund manager Ray Dalio’s belief the yuan will replace the dollar sooner than conventional market wisdom believes. But the Bridgewater Associates founder makes a plausible case that the changing of the guard many pundits hope would never happen may be afoot.
Four: the digital future is now. As Fed Chairman Jerome Powell experiments with tapering and rate hikes, PBOC Governor Yi Gang’s team is about to roll out a digital currency, the first by a major monetary authority.
China’s first-mover advantage matters when it comes to rewriting the future of money. By February, when Beijing hosts the Winter Olympics, the PBOC hopes to have an “e-yuan” ready for circulation. The US, Europe and Japan are lagging far behind.
The more a digital yuan gains global acceptance, the more Xi’s ambitions to increase China’s role in global finance and trade comes to fruition. And the more Washington, Frankfurt and Tokyo will find themselves playing catch-up. And investors – and central banks – might increase their yuan holdings.
Five: America’s bankers call their loans. The cornerstone holders of Washington’s ginormous debt are all in Asia, especially Japan and China. Asia’s top 10 holders are sitting on about $3.5 trillion of US Treasury debt just as inflation surges the most in decades.
Questions over Treasury holdings
Reserve currency status is indeed an “exorbitant privilege,” as one-time French finance minister Valery Giscard d’Estaing famously said. With it, though, comes urgent responsibility. Now that inflation is perking up, the Fed needs to ensure it’s getting ahead of things. Otherwise, Washington’s Asian bankers might dump Treasury holdings en masse.
The Fed does have options, says Columbia University economist Willem Buiter. “Simply put,” he says, “the additional federal fiscal deficits must be monetized.”
Buiter notes that in general Team Powell “has done a great job so far” expanding its balance sheet by 70% from March 2020 to January 2021 – from $4.2 trillion to more than $7.4 trillion. The Fed, though, “now must prepare to buy up the federal debt issued by the Treasury to fund its latest fiscal ambitions,” Buiter says.
All told, though, the dollar is heading into a rather precarious year of uncertainty, volatility and more than a few moments of existential dread.
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