There are a lot of conflicting forces expected to impact currency markets this week. The first was the meeting of oil-producing nations in Doha that analysts believe ended in failure. Beforehand, there was talk of a production cut that would have supported oil prices. Instead, there was no agreement and oil prices fell immediately. If oil weakness holds, the dollar should strengthen reflexively. Amazingly, however, that may not be the largest story of the week.
There is a rumor that China is planning to move on the dollar on the 19th, supported by Russia. There have been similar rumors with date-certain outcomes that came and went without incident. This one could be similar.
There are two factors that make it a little more intriguing, however. First, Saudi Arabia has made a direct threat against the dollar. They have made it known that they are willing to dump $750 billion worth of Treasury bonds, which many believe would destroy the Petrodollar. Their next move would be to begin accepting another currency, other than the dollar, in exchange for oil sales. Would this include a gold-backed Yuan? Why would Saudi Arabia threaten this? They said they would do so IF we allowed lawsuits against the Saudis for 9/11. The Saudis know that there are 28 pages of the 9/11 Report that reportedly implicate Saudi officials and have been withheld from the American people.
How real is this threat? It comes from the highest levels. The Saudis can point to a historical precedent where we threatened to dump British bonds if the British and French attempted to retake the Suez Canal from Nasser’s Egypt. In addition, this threat happens at the same time the Russians and Saudis have been negotiating a possible cut in oil production to boost prices. The Russians have been pushing for the world to dump dollars for some time. They persuaded the Chinese in 2013 and China has sharply reduced their Treasury holdings. Now, are they influencing the Saudis? There should be little doubt that they have been trying to get the Saudis into their orbit. Using the 9/11 revelations and possible lawsuits as leverage is exactly the kind of thing they would do. And they have become more threatening with their military in recent days. Don’t forget that even our Secretary of State, John Kerry, warned that sanctioning Iran could lead to the dollar losing reserve currency status.
We do see China expanding a commitment to gold, which is a big part of the speculation behind the April 19 fear. It is true that there is a Chinese Yuan/gold fix that will take place April 19. It was once a rumor but is now confirmed. But is this a market evolution rather than a direct attack on the dollar? The motive and outcome are hard to determine. It is clear that China is making massive economic changes, injecting over $1 trillion worth of money internally.
IF both Saudi Arabia and China turned against the dollar at the same time, it would have an impact. These are two major players in the global economy that have accumulated massive reserves.
Certainly the Federal Reserve could step in and buy the dumped Treasuries to minimize the direct blow. Such a move would not be without consequence, however. It would weaken the currency over the long run reducing confidence in the dollar because it would appear that the government was deliberately monetizing its debt. There is a tipping point at which the world turns away from dollars. Whether a coordinated Saudi/China dump would get there or not is an open question. But there have been official Chinese editorials calling for the courage to turn away from the American dollar. Not long ago, this became official policy, to “de-Americanize the world.” Just recently, the Chinese convinced Hungary to issue debt denominated in Yuan instead of dollars. And the Chinese have started to sell down their Treasury holdings. This is a trend, not an isolated incident.
Of course, the reason that Saudi Arabia and China might choose to pass on a dollar attack is the simple fact that the blowback would be very damaging to themselves. Saudi Arabia depends on a strong global economy to buy oil products and an attack on America and the dollar could easily create serious pain. Likewise, the Chinese need a reasonably stable dollar to help their exports. At some point they will seek to displace the dollar and the Yuan has been granted a seat at the reserve currency table. But is this Communist nation ready for a dollar collapse?
We should not exclusively count on rational economic behavior (from our perspective) from either Saudi Arabia or China. The Saudis have shown short-term irrationality to achieve longer-term purposes. A good example can be seen in the oil-price drop. The Saudis historically were the marginal producer, meaning they would pump extra oil when prices got too high and threatened demand. If prices fell, they would produce less to strengthen the market. Since late 2014, however, they have increased production even as oil prices have fallen. Their purpose is to reduce competition, not maximize revenues. How else can you explain rating production as prices decline? Using very rough numbers, why would a nation pump 10 million barrels per day at $40/barrel when they could reduce output to 6 million barrels per day and earn $80? Clearly, it would be better to get $48 million daily than $40 million, especially if it meant reducing your cost of goods sold by 40% as well. But the purpose is not short-term revenue maximization. That’s why the threat of a dollar attack must be taken seriously. We are already in an “oil war” with Saudi Arabia as they attempt to bankrupt our domestic shale industry.
Likewise, the Chinese aren’t guaranteed to be short-term rational. That’s how Vice Chairman Chi of China’s military commission could with a straight face discuss a large-scale nuclear attack on America with 100 million or more lost lives, knowing the potential for retaliation. He said it would make sense if it guaranteed a China century. In other words, the Chinese are willing to endure short-term pain for what they believe to be long-term gain. Keep in mind that the Chinese may well be fooling themselves. They claim trillions of dollars worth of foreign currency reserves. But, as Gordon Chang points out, these reserves may not be all they are cracked up to be. There is a possibility that China is counting Yuan-based assets in their holdings, something that would be clearly illegitimate. How can you support your currency by backing it with itself?
All of this brings us back to the dollar and this week. It is most likely that then dollar will survive mid April intact. But it is not inconceivable that the dollar could come under attack by China and even Saudi Arabia under Russian influence. What can you do? Some have suggested getting a little extra cash to have on hand. If the dollar were attacked, ironically, cash would initially be scarce. It is sort of like how the water recedes before the tsunami hits. Cash becomes very dear even if there are legitimate threats to the dollars’ value. You may also want to hold extra cash in your portfolio. Bonds would certainly be hurt if China and Saudi Arabia dumped their holdings. Stocks also would suffer, at least in the short run from the uncertainty.
In terms of what we do as a nation, we should inform the Saudis that we will not be blackmailed. In fact, any move against the dollar will be met with direct response and it won’t be pleasant. Further, we should immediately ramp up our domestic energy development by opening Federal lands for exploration and production. In addition, we should immediately undertake measures to foster greater domestic economic growth. This means we should reform tax rates and reduce regulation. America can enjoy another economic boom if we get those policies right. Finally, we should allow for the repatriation of foreign earnings by american companies back into the United States without penalty. That would unleash $2 trillion, more than enough to cover any dumping by Saudi Arabia or China. These are the kind of actions we suggested in the book Game Plan.
The bottom line is that we are already involved in a global economic war. There are threats to the U.S. dollar and some believe the current week is critical. Time will tell whether or not that is the case. Something to watch for, especially this week.