The New Cold War & The Death Of The Dollar

As if there wasn’t enough in 2020 to keep you thinking deeply during a shower, I think it’s worth covering one of the seminal power struggles of this century.

The escalation of tensions between these two countries has had an impact on the economies of the other major world economic powers, who have been reduced to spectator status in what many now call the New Cold War.

Of course, I can only be talking about the heightened tensions between the United States and China.

Coronavirus, Hong Kong & Taiwan, frequent trade war flare-ups, and the future dynamics of world politics give us every indication that we are moving towards a bipolarisation of the world in the years to come.

On the one hand, we will have the United States, and on the other hand, China. In the midst of these two ultra-dominant world powers, the European Union, Russia, India, and other major & minor world powers will have to find out what position to adopt.

As tensions continue to flare, countries will have to choose to align themselves with either power broker or choose to go their own way.

What makes that latter option increasingly difficult, but also increasingly desirable, is the evolving role of the world’s reserve currency: The US Dollar.

Choose one of the two camps, or rather try to exist with their own voices.

The U.S. dollar is an incredible weapon for the United States

American domination over the world is rooted in its currency. The term exorbitant privilege refers to the benefit the United States has due to its own currency (i.e., the US dollar) being the international reserve currency.

Following the Second World War, the U.S. Dollar has unquestionably been the world’s reserve currency:

World — Allocated Reserves by Currency for 2019 Q4 — IMF

At the end of 2019, more than 60% of the world’s currency reserves were denominated by the U.S. Dollar.

But, of course, we’re currently witnessing the clown car of catastrophe called 2020, so all previous status quo notions have been thrown out the window.

Despite what the massive economic volatility of 2020 might suggest, the domination by the U.S. Dollar has actually strengthened since the beginning of the year.

Even if economic indicators look absolutely dire for the US, the world at large is still highly dependent on the US to export more and more greenbacks — so the Fed has fired up those money printers.

Looking to act upon this dependency, many countries, especially China and Russia, have acted to put an end to the hegemony of the U.S. Dollar.

Indeed, this may be impossible — not to mention, the majority of the world isn’t crazy about the idea of replacing the U.S. Dollar with the currencies of notorious state-controlled command markets.

Indeed, there is a well-known mantra that is often repeated: “Don’t fight the Fed”. The dominance of the U.S. banking system and the liquidity of the U.S. dollar, supported by the dark machinations of the Fed, seems set to give undisputed supremacy in the global monetary and financial system for an indefinite period of time.

But, history is replete with examples of empires that were “unsinkable” and “invincible”, yet nothing remains of them today. The only constant is chaos.

Indeed, it is more probable that the gravest threat to the U.S. Dollar is not an external one, but rather comes from within.

President Trump’s brazen disregard for the political status quo and Fed Chairman Powell’s brazen disregard for the monetary status quo is being watched by those who will eventually hold power. They will have the opportunity to build upon these present methods; it isn’t likely that they will see giving back power gained as the fortuitous path forward.

Those sentiments are shared, in form and function, by those looking to subvert the U.S. Dollar with their own currency.

China, Russia, and many others would like to break the hegemony of the U.S. dollar

China intends to try reducing its U.S. dollar dependency, as its initiative to create a sovereign digital currency shows. The adoption of this e-RMB may well benefit from China’s Belt and Road Initiative. Indeed, the U.S. dollar also derives its strength from the fact that it is used for most of the world’s trade transactions.

The use of the e-RMB could be seen as an attractive alternative for countries and companies wishing to trade with each other without having to use the U.S. dollar.

Recent statistics also show that China has been one of the main buyers of gold for several months. The goal here is to use gold as a hedge to reduce its dependence on the U.S. dollar.

Russia has also been following this strategy for several years now, as shown by the evolution of its gold reserves:

Russia’s gold reserves since 2006

Russia has thus spent more than 40 billion dollars over the last 5 years to drastically strengthen its gold reserves.

Gold now accounts for more than 20% of the reserves of Russia’s central bank.

Russia isn’t alone. The EU is also making moves.

The euro could have been a serious alternative to the global hegemony of the US dollar. Moreover, the euro already accounts for 20% of the world’s currency reserves.

Nevertheless, the political uncertainty in the European Union does not offer many sufficient guarantees. The recent plan of the European Commission to support its stimulus budget in the fight against the effects of the coronavirus, backed by EU-wide taxes, could change this situation.

Some see this as the first foundations of a true fiscal union — the “United States of Europe”. 

Such a solution still seems far away, but such consolidation would be likely to strongly increase the demand for the euro.

Another novelty that is likely to reshuffle the cards at world level is the weakening of the links between the United States and cornerstone commodities.

For example, the price of oil is priced and traded in U.S. Dollars and has served as one of the major reasons why most central banks and world investors wish to hold the U.S. dollar as a priority. But, why is oil drilled in Saudi Arabia priced in U.S. Dollars?

Well, oil is priced in dollars because, through Bretton Woods, the Dollar was pegged to gold and everything else was essentially pegged or floated to the dollar. The world was flooded with dollars after WWII which partially led to the present American consumerism, but it also enabled the world to essentially use the dollar as they would gold. Eventually the US went off the gold standard all together. In the meantime, oil, which is a global commodity, was traded using the U.S. Dollar — which drastically simplified the whole system. The system has remained in place due to inertia.

In order to change the currency used, the world would have to be flooded with a different currency (which doesn’t make sense since the US has the world’s largest economy)and while the Fed may whit away the value of the dollar, it’s highly unlikely that it will default given how deeply ingrained it is. Therefore, it is not susceptible — realistically — to any speculative attacks. While currencies such as the Euro hold a substantial percentage of reserve holdings, the dollar is still THE reserve currency.

Under the present circumstances, the only realistic alternative would be to have a somewhat balanced basket of currencies, including the Dollar, containing the drivers of world trade. Seems reasonable, right? Well, if this is how you base economic activity, do you buy oil with Yen one week and Pounds the next? Does this increasingly difficult pursuit of “stability” outweigh the negatives of using the U.S. Dollar?

Unfortunately, a basket of currencies is inherently unstable from a global perspective since the constant shifting of portfolios would add constant volatility to the market. Granted, the Federal Reserve is not a lesser evil, but we simply have to live with the fact that there is no perfect system — especially when the foundation of any system is based on the bordered rigidity (and restlessness) of sovereign currencies.

Let’s go back to oil as a focal point of the U.S. Dollar’s role globally.

Since the United States claimed energy independence through its shale oil production, Saudi Arabia’s strategy has been to put continuous pressure on U.S. shale oil producers. How? By lowering the price of their oil so that their activity is no longer profitable.

This has created enormous tensions between the Trump administration and Saudi Arabia.

As the United States does not intend to change its energy strategy, Saudi Arabia will have to find a new preferred buyer for its oil. Given its huge energy needs, especially as it tries to move beyond a manufacturing-based economy, China will be that buyer.

If China were to become the preferred buyer of Saudi Arabian oil, it would without a doubt demand that the price of this oil be set in renminbi.

This would add to decoupling by lowering the need for the U.S. dollar globally.

Also questionable is the attitude of the Fed, which has been supporting the U.S. government’s policy since the beginning of the coronavirus crisis by buying more and more Treasury bonds.

In order to buy these bonds, the Fed is printing U.S. dollar in huge quantities, even if it means taking the risk to enter into a cycle of hyperinflation. As we covered last week, this will likely snowball into the Fed buying stock indexes and eventually serve as the justification for negative interest rates and cash bans.

It goes without saying that this will contribute to a decline in confidence in the U.S. dollar for hundreds of millions of people around the world, if they had any confidence to begin with. Indeed, it is increasingly hard to believe that the U.S. Dollar has any real value when the Fed can print $3 trillion in the blink of an eye.

A post-U.S. dollar world is clearly taking shape — what will it look like?

Bitcoin will have a major role to play in this post-U.S. dollar world

What is clear is that we are in a bipolar world in which the United States and China are at odds with each other. This power struggle could result in a new single-superpower world. But, what is more likely is that it will be mutually-assured destruction. Importantly, it will weaken the U.S. dollar’s status as a global reserve currency.

As nature abhors a vacuum, an alternative will have to emerge if the US dollar were to lose its omnipotence.

The euro, gold, and e-RMB are potential alternatives. 

Nevertheless, these different alternatives suffer from major systemic flaws.

This solution that emerges from the people is Bitcoin.

Mind you, this is not to say Bitcoin becomes the new US Dollar — rather, Bitcoin will evolve the role of the US Dollar. The days of a centralized & sovereign reserve currency are over. The world is losing its appetite for systems that affect the entire world at large based on a small oligarchy of self-interested plutocrats.

Conversely, Bitcoin has the advantage of having no leader — It belongs to all its users. 

Bitcoin is therefore politically neutral.

Its monetary policy is not defined by any country or human. It is governed by its source code, and only a complete consensus of its community could change its fundamental tenants, such as the total supply or supply schedule.

In all likelihood, that will never happen — Bitcoin’s genius is that it embraced the simple fact that humans are selfish always.

Rather than try to hide that fact behind power structures whose checks and balances inevitably fall due to the erosion of corruption over time, Bitcoin’s monetary policy embraces selfish human nature and turns that into its greatest strength. How remarkable it is to see inherently selfish actors collectively benefitting one another through their pursuit of selfish means.

It also highlights the virtues of quantitative hardening.

In a world where digitalization is becoming the norm, the need for a digitally native protocol for money on the Internet is expanding rapidly.

It’s not a stretch to see that Bitcoin will facilitate trade between all players around the world — the money that lives beyond borders and conventional barriers will help bring them down. It will free us from the dominance of the United States and the notorious extraterritoriality of U.S. laws.

Increasingly in the future, as more and more countries trapped between the U.S. and China power struggle, we will see countries emancipate themselves by opting for decentralized currency. That is a certainty.

The big issue, however, will be how power brokers like China, whose e-RMB is an attempt to thwart the rise of Bitcoin, will stand in the way of this adoption.

In any case, Bitcoin is bound to have a major role to play in the post-U.S. dollar world of the future.

No one can know how far this New Cold War will go, but we can be sure that uncertainty will create the perfect springboard for digital adoption.

The future belongs to those innovations that hedge against uncertainty.