Tag: dollar

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The New World Dis-Order

The economic sanctions against Russia are likely to have a bigger economic impact on Europe and the United States than Russia.  The potential changes are not yet reflected in the financial markets.

On February 28, the US Treasury Department announced that it would freeze Russian central bank assets that are held in the United States.  The US also imposed sanctions on the Russian Direct Investment Fund, which is a sovereign wealth fund.  European allies and Japan joined the US in implementing similar sanctions on Russian assets.  The scale and scope of the sanctions were unprecedented.  The EU Council’s sanctions included the 351 members of the Russian State Duma and an additional 27 individuals and entities.

On April 6, the US in coordination with G-7 countries and the European Union, announced additional sanctions that will ban all new investment in Russia, increase sanctions on financial institutions and state-owned enterprises in Russia, and sanction Russian government officials and their family members.

Prior to the invasion of Ukraine, on February 4, Russia and China agreed on 30-year natural gas deal via a new pipeline, which is expected to be in operation within 3 years.  The agreement had been in the planning stage for years, but it serves as a reminder that Russia has other markets to serve besides Europe for its natural gas.

It is naïve to think that one country’s actions against another country will not generate responses, including some countries that are not the target of the initial action.  In response to the economic sanctions, Russia has taken the following actions:

  • March 10 – Russia suspends fertilizer exports to “Not Friendly” countries. China warns the US against retaliation.
  • March 31 – Russia issues a decree that payments for natural gas should be in rubles. Kremlin spokesman Dmitry Peskov said that Russia “won’t engage in charity if Europe refuses to pay in the Russian currency.”
  • Pavel Zavalny, Chairman of the Energy Committee of the State Duma in Russia, said that European countries will “pay in hard currency, and this is gold for us” or they can pay in rubles. “Friendly countries” such as China or Turkey can pay with their national currencies or the ruble.
  • The Russian invasion effectively cut off Ukrainian exports of wheat. Russian exports of wheat are expected to decline this year.

The suspension of fertilizer exports to selected countries and limited exports of wheat prompted President Biden to acknowledge at a March 24 press conference in Belgium after NATO and G7 meetings, “Yes, we did talk about food shortages and it’s going to be real.”

According to reports on March 9, the White House requested phone calls with Saudi Crown Prince Mohammed bin Salman and the UAE’s Sheik Mohammed bin Zayed al Nahyan to discuss increasing exports of their oil to the United States.  However, both declined the requests to speak with President Biden.

On March 15, Dow Jones reported that Saudi Arabia is in active talks with China to price some of its oil exports to China in the yuan currency instead of US dollars.

The use of US dollars beyond our borders is enormous in size.  What is often called the “Eurodollar market” encompasses bank deposits, bonds, loans, imports, and derivatives outside of the US that must be settled in US dollars.  Michael Every of Rabobank estimated the size of the Eurodollar market at $57 trillion at the end of 2018.  For his explanation of the Eurodollar market, see The Eurodollar Market Is The Matrix Behind It All – Daniel’s blog (wordpress.com).

Paul Craig Roberts, economist and chairman of the Institute for Political Economy, offered his opinion on the sanctions and its impact on the US economy:

What the sanctions have done is to destroy the dollar-based world that allowed the Americans to impose the financing of their huge trade deficit, due largely to US corporations offshoring their production for the US market, on the rest of the world.  Russia, China, central and east Asia will now create their own methods of payment separate from the West.  This will destroy dollar hegemony and American power.

The obvious question is how far will the US dollar decline if a significant portion of international trade requires payment in currencies other than the US dollar?

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA

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Bonds, the Dollar, and Leverage – 4/6/2021

In the title of his latest commentary, Ray Dalio, Founder of Bridgewater Associates, asks “Why in the World Would You Own Dollar Debt?”  He argues that the current dynamic is “typical of the late stage of the long-term debt cycle.”

The world is a) substantially overweighted in bonds (and other financial assets, especially US bonds) at the same time that b) governments (especially the US) are producing enormous amounts more debt and bonds and other debt assets. This is particularly true for US bonds. US bond holdings are over a third of global bond holdings held by central banks, sovereign wealth funds, and international investors with the next largest country/currency bond being euro bonds at only roughly 60% of US bond holdings.  Their overweighted position in US bonds is largely because of the “exorbitant privilege” the US has had being the world’s leading reserve currency, which has allowed the US to overborrow for decades.  The cycle of becoming a reserve currency, overborrowing, and being overindebted threatening the reserve currency status is classic.

Some international investors are shifting a portion of their fixed income allocation from US$ bonds to Chinese bonds, which now account for about 6% of global portfolios.  Given the low interest rates in many countries, investors have also been willing to invest more in common stocks and precious metals.  However, bonds still have a place in portfolios for now, given valuation levels in the stock market that have already priced in a strong recovery.

The recent disclosure of some large bank losses due to business with Bill Hwang’s Archegos Capital raises some questions about derivatives and capital markets.  A record level of margin debt has contributed to higher prices in the stock market, but derivatives have added another source of leverage for speculators.

Bloomberg estimates that derivative contracts with Archegos caused the forced liquidation of more than $20 billion in holdings.  Much of the leverage used by Archegos was provided by Nomura Holdings Inc. and Credit Suisse Group AG via equity swaps and a type of derivative contract called contracts for difference.  Archegos may never actually have owned most of the underlying securities, preferring to bet on the highly levered derivatives contracts instead.  Among the stocks impacted by the forced liquidations was ViacomCBS which has dropped nearly 60% since March 22.  The prime brokerage losses have not been fully disclosed yet, but Credit Suisse has reported a loss of $4.7 billion so far due to their business relationship with Archegos.  Total losses for all banks are likely to exceed $10 billion.

Some of the large banks also have exposure in the precious metals markets with large short positions in silver, platinum, and gold.  Futures contracts for these three metals have a higher level of contractual open interest relative to global production than other commodities.  The short positions are highly concentrated among among eight large bank trading groups.  For example, the eight largest traders are net short silver an amount that would require 180 days of global mine production.  They are also net short platinum by 117 days and gold by 86 days of global mine production.

Investment demand for bullion and coins has picked up considerably from prior years.  Sprott Asset Management compared the total demand for coins and bars at three government mints: the US Mint, Perth (Australia) Mint, and Royal Canadian Mint.  For 2020, sales of gold coins and bars at the three mints was 157% higher than 2019, while the sale of silver coins and bars was 54% higher.  Gold and silver bullion ETFs have increased their inventories of bars.  Buyers of COMEX contracts are also requiring delivery of physical metal at higher levels than they did in past years.  Given government and central bank policies around the world, investment demand for precious metals is likely to continue or rise from current levels.  Higher prices should follow.

If you have any questions or comments, please contact me.

Robert G. Kahl
CFA, CPA, MBA