22 Apr De-Globalization and De-Dollarization

“The enormous amount of debt and money creation over the past 13 years has changed the nature, and also reduced the value, of debt and ‘money’.” – The Lonely Realist

As TLR wrote in July 2019, America’s trade sanctions initiated, and as TLR wrote in April 2021, America’s COVID-19 money-printing and stimulus policies amplified, the isolationist/America First policies that have accelerated de-globalization and lit the fuse for inflation and the digitization of currencies. America’s response to the invasion of Ukraine has further enhanced de-globalization and highlighted a trend towards de-Dollarization. Not only have sanctions plus the pandemic plus the response to Russia’s invasion inflamed resource and manufacturing nationalism, they have propelled “money diversification” as nations and their citizens act to allay concerns about Dollar weaponization.

The Dollar has been the global Reserve Currency – the very definition of “money” – for the past 75+ years. That’s a long time. Prior to 1971, the Dollar was backed by gold. That worked until it didn’t …, until America couldn’t afford it any longer. When, in 1971, America went off the gold standard, it became responsible for maintaining global price stability by ensuring that the Dollar remained firmly anchored. The Dollar, a currency made up of pieces of paper, thereafter was underwritten by America’s implicit guarantee. The rest of the world honored and respected that guarantee because America was the global hegemon and the world’s largest and most successful economy. America continued to fill the role of global hegemon, adhered to the Rule of Law and due process, maintained a prudent tax and debt structure, and preserved the world’s most powerful military and, as a result, the Dollar continued to be accepted as the world’s most secure currency and America continued to be the preferred destination for an outsized share of the world’s products and services. That benevolent environment conferred a truly “exorbitant privilege” on America and its economy (as discussed by TLR here). That privilege has worked to America’s advantage …, at least until now. America’s recent detonation of the Nuclear Dollar has changed both the perception of America’s Dollar guarantee and the reality of Dollar security, undercutting the sanctity of the Dollarized global financial system. 2022 therefore marks the beginning of a new multi-currency era, one in which nations, companies and individuals will utilize substitutes for the Dollar in a broadening range of transactions, an outcome avidly sought by America’s competitors …, members of the Axis of the Sanctioned.

“Money” was created to avoid the difficulties inherent in swapping labor for labor, labor for goods and goods for goods. Among other things, “money” fills the need for simplicity and consistency as a medium of exchange, eliminating the necessity for arranging person-to-person negotiations for the multiplicity of goods and services that propel commerce. An international reserve currency reduces commercial frictions and thereby facilitates easier cross-border exchanges of goods and services. To achieve smooth-flowing commerce, that “money” – in whatever form – must be (1) widely-used, (2) accepted in transactions from one party to another, and (3) a store of measurable value. Nothing today serves that purpose better than the Dollar. No currency, metal or crypto is as widely-accepted. Nothing is as stable or as measurably valuable as the Dollar. Although aspirational, neither the Chinese Yuan nor the Euro nor the Russian Ruble nor Bitcoin is ubiquitous, has been accepted everywhere for a broad range of transactions, or has been viewed in the same way as a store of measurable value. That now is changing. Nations are well-aware from the experience of the Russian Central Bank that the Dollar is not the safe haven storehouse for their national reserves that they had thought. America can use the Nuclear Dollar as a sword whenever it feels threatened. (According to Vyacheslav Volodin, speaker of the Russian Duma, “Anyone who keeps money in Dollars today can no longer be sure that the U.S. will not steal their money.”) That changes the equation … and countries will be changing their practices accordingly. (The media have reported, for example, that CNOOC, China’s largest offshore oil and gas producer, is preparing to sell its energy interests in Britain, Canada and the U.S. because of concerns that its assets could become subject to Western sanctions. That decision undoubtedly also is affected by the fact that China now can obtain almost limitless oil and gas from Russia, Iran, Saudi Arabia and the UAE.) Companies and individuals will follow.

Russia is the single largest exporter of commodities and China is the single largest importer. They are natural partners. Australia, Saudi Arabia, Brazil and the UAE are the next largest exporters and Japan and India the next largest importers. In a world of American-led sanctions, those exporters and importers have an incentive to  partner with each other and thereby create new relationships that change global loyalties and economics … to the West’s disadvantage. The most recent actions of China, India, Saudi Arabia, Brazil, Turkey, Hungary, Serbia and the UAE (among others) in avoiding condemning Russia’s invasion and in side-stepping enforcement of American sanctions are indicative. They point to trending de-Dollarization as well as the monetization of commodities.

Russia cannot afford to be paid in sanctioned Dollars or Euros. It needs to be paid for its commodities in Rubles, Chinese Yuan, gold or usable goods. Its commodities therefore are swappable “money” because its oil, gas, wheat and fertilizer are in great demand and acceptable “currencies” to exchange with its trading counterparties. (In a recent phone conversation with Vladimir Putin, Recep Tayyip Erdogan suggested that Turkey and Russia conduct trade using Rubles, the Chinese Yuan or gold.)

The monetization of commodities triggered by the West’s response to Russia’s invasion of Ukraine means that the value of commodities in both absolute and relative terms will increase and Dollars will cease to be the sole pricing medium. This will have profound long-term effects on Dollar value and the American economy. Moreover, the rerouting of commodities to commodity importers willing to trade with Russia – including China, India, Turkey, and Iran – will increase their cost. Transportation routes, tanker commitments and financing lines will need to be reshuffled. The increased value of commodities will benefit commodity exporters and the discounts Russia makes available to its trading partners will decrease relative costs for friendly commodity importers. Those importers will pay for sanctioned commodities using something other than Dollars and therefore will need to hold fewer Dollars in their national reserves …, meaning that there necessarily will be fewer Dollars circulating in the global financial system to be used for the purchase of US Treasury securities …, meaning that fixed income demand will decrease and interest rates on US Treasuries and fixed income securities accordingly will increase. The effect of de-globalization and de-Dollarization therefore will be commodity and interest-rate inflation, reverberating across a broad swathe of global and domestic markets. Those effects, both direct and collateral, will spiral, adversely affecting the economies in the West to the benefit of China and other members of the Axis (e.g., Iran and Venezuela). Cumulatively, they will weaken America, reduce worldwide growth and prosperity, accelerate de-globalization, and lead to a bipolar global financial system where the Dollar gradually will lose its exalted position and America’s “exorbitant privilege” will dissipate. An era of de-globalization accordingly will pair with de-Dollarization. Both will be bad for America.

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Finally (from a good friend)