The Great Dollar Paradox
The de-dollarization story is everywhere.
You see it in publications from The New York Times to The Economist and in financial media including CNBC, Fox Business and Bloomberg.
The idea is that countries around the world are preparing to ditch the dollar. This takes many forms including efforts by China to pay for imported oil from Saudi Arabia and the UAE with yuan and a major bilateral agreement between China and Brazil that allows each country to pay for exports from the other using their local currencies.
Russia got in the act by agreeing to receive rupees for oil delivered to India and paying for imports from China with rubles. All these efforts will be converging and coming to a head in late August when the BRICS (Brazil, Russia, India, China, South Africa and other invited countries) meet to announce a new BRICS+ currency linked to gold.
With all of that going on, one might expect to find the dollar in freefall. Yet that’s not the case.
The dollar has been strong lately and I expect it to get stronger in the months ahead. What gives? How can the dollar be under global attack and yet be strong at the same time?
Strong Compared to What?
The answer is found in the way you measure value in any currency. Dollar strength or weakness is typically measured in major currency indexes, including DXY (used for futures trading and quoted in The Wall Street Journal) and the Bloomberg Dollar Index.
Other major indexes include those computed by the Federal Reserve (I use the Fed indexes in my own research and analysis). What all these indexes have in common is that they compare currencies with currencies, usually the major reserve currencies.
A typical dollar index will compare the dollar with a basket consisting of euros, sterling, yen, Swiss francs and perhaps one or two others. Because of the importance of the euro in world trade and reserves (second only to the dollar), these indexes tend to be just more complicated versions of the euro/dollar cross-rate.
The emerging markets’ currencies are typically left out of such indexes. Meanwhile, the bilateral currency deals described above do not include dollars. When you look at a bilateral currency deal involving yuan or rubles, the dollar is not included at all.
So it’s entirely possible to have a strong dollar (measured mainly against euros) and a growing de-dollarization trend involving yuan, rubles and rupees. The two trends are talking past each other.
The Golden Ruler
Is there some way to tell if the dollar is actually getting stronger or weaker without making reference to reserve currencies or EM currencies?
Yes. The answer is gold. Think of gold as a ruler that measures dollar strength or weakness.
Gold is not a currency, and the comparison is made by the weight of gold, not currency-to-currency. When the dollar price of gold is lower, the dollar is stronger, and vice versa.
But the new BRICS+ currency may throw a monkey wrench into this market by linking itself to gold. In that case, Russia and China will have a strong interest in higher gold prices because that means their BRICS+ currency will be worth more. And that may trigger the real decline of the dollar.
The BRICS+ gold-backed currency is actually the reflection of a greater trend that’s been going on for over a decade…
The Trend Is Gold’s Friend
The year 2010 marked a major inflection in central bank gold purchases and the overall level of gold reserves held by central banks and finance ministries on a global basis. Let’s back up a bit…
In 1950, the United States held about 20,000 metric tonnes of gold bullion. By 1970, the U.S. gold hoard had shrunk to 9,000 metric tonnes. That gold did not disappear; it was delivered to Germany, France, Italy, Japan and other trading partners to cover U.S. trade deficits under the old gold standard.
Beginning in 1970, gold held by central banks and finance ministries declined significantly. The U.S. sold 1,000 tonnes between 1970 and 1980 and encouraged the IMF to sell about 1,000 tonnes also in a failed effort to suppress the price of gold.
After 1980, the U.S. did not sell any more gold, but encouraged the U.K. to sell over 300 tonnes in 1999. Then Switzerland sold another 1,000 tonnes between 2000 and 2010. The IMF sold 400 tonnes in 2010 also. Canada sold 100% of its gold reserves, which were not that high to begin with.
All of these efforts to suppress gold prices ultimately failed. Gold hit a then-all-time high of $1,950 per ounce in 2011 (that record was surpassed in recent years at $2,060 per ounce in 2020).
Finally, in 2009 the central banks threw in the towel and became net buyers of gold bullion. That trend has been in place ever since.
The increases have been spectacular, resulting in a rise in total official gold holdings from about 32,000 tonnes in 2008 to 35,000 tonnes today. What’s different today is the composition of the gold holders.
BRICS+: The New Gold Bloc
The U.S. has not increased its holdings since the 1950s. Nor have other major gold holders such as France and Italy. Instead, the increases are in Russia, China, Vietnam, Mexico and many other emerging-market countries.
Many of those countries with the largest increases are members of the BRICS+ currency union that will soon announce a new gold-linked currency to challenge the role of the U.S. dollar in global payments and reserves.
Overall, the first quarter of 2023 was the strongest quarter on record for central bank gold purchases with central banks buying a combined total of 228 tonnes.
We actually have a new champion in the gold purchase arena, and it’s not Russia or China — it’s Singapore.
In just the first three months of 2023, Singapore purchased an amazing 68.7 tonnes of gold bullion, making Singapore the world’s-largest central bank gold buyer for the first quarter.
One can speculate about whether this gold buying is an aspect of de-dollarization, preparation for the new BRICS+ gold-backed currency or simple prudence in an uncertain world. But the trend is undeniable.
Central banks generally know more about what is going on behind the scenes in the global monetary system than anyone. If they’re hoarding gold, maybe you should too.
There’s still time to get on the BRICS+ bandwagon.
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