Could Chinese Gold Be the Straw That Breaks the Dollar's Back? / Commodities / Gold & Silver 2024
There are cracks in the foundation of dollar dominance. CouldChinese gold be the straw that breaks the dollar’s back?
In a column published by the Telegraph,economist Julian Jessop points out that people have been predicting thedollar's demise for decades. Eventually, they'll be right.
“And that day may be drawing much closer.”
It may seem premature to talk about the demise of the dollar.Based on the dollar index, the greenback is stronger than ever. But thisdoesn’t necessarily reflect the greatness of the dollar. It’s more a functionof weakness in other global currencies. As the saying goes, the dollar is thecleanest dirty shirt in the laundry.
And if we look at the fundamentals underpinning the dollar,there are clearly issues.
The biggest problem is U.S. government borrowing and spending. Uncle Sam runs massive deficits every single month, requiring the Treasury to borrow more andmore. The national debt has ballooned to $35.5 trillion and continues torapidly increase. Constant federal government borrowing floods the globalmarket with U.S. debt and dollars.
Of course, the world needs dollars. But the demand isn’tinfinite. At some point, America’s fiscal irresponsibility will catch up withher.
Then what?
The Dollar Milkshake Theory
You may wonder how the dollar keeps plugging along despite U.S.monetary malfeasance.
Several factors underpin the greenback – chiefly its role as theglobal reserve economy.
In 2010, Santiago Capital’s Brent Johnson wrote a white paperthat developed the “Dollar Milkshake Theory.” In a nutshell, Johnson arguesthat the dollar will generally strengthen during times of economic uncertaintybecause of its role as the reserve currency. Here’s how Medium summarized the theory:
“Imagine a milkshake made with different ingredients, such asmilk, chocolate syrup, and vanilla ice cream. The milk represents the USdollar, the chocolate syrup represents other currencies, and the vanilla icecream represents global liquidity. As the milkshake is blended, the ingredientsare mixed together. However, the milk, which is the heaviest ingredient,settles at the bottom of the glass. This is similar to how the US dollar, asthe strongest currency, tends to strengthen during times of economic stress.”
The Milkshake Theory assumes that the dollar will always remainthe reserve currency and thus serve as a safe haven. But what happens if theworld loses faith in the dollar?
Jessop points out three factors that underpin the dollar. Thinkof these as the milk in the Milkshake Theory...
The size of the U.S. economy and the depth of its financial markets create a massive pool of dollar-denominated assets ideally suited as a global store of value.
The vast majority of global trade takes place using dollars. That means the world needs a lot of dollars.
For these reasons, the world needs dollars and lots of them. Butnothing guarantees the status quo will continue into perpetuity.
The Milk Is Getting Sour
Everybody loves a milkshake – unless the milk is sour. And thereare signs that the milk in the dollar milkshake is starting to curdle.
The rise of the BRICS economic bloc is positioning itself tochallenge the role of the dollar as the reserve currency.
BRICS is an economic cooperation bloc originally made up ofBrazil, Russia, India, China, and South Africa. As of Jan. 1, 2024, the blocexpanded to include Saudi Arabia, Egypt, the UAE, Iran, and Ethiopia.
More than 40 other nations have expressed interest in BRICSmembership.
The expanded BRICS has a combined population of about 3.5billion people. The economies of the BRICS nations are worth over $28.5trillion and make up roughly 28 percent of the global economy. BRICS nationsalso account for about 42 percent of global crude oil output.
The BRICS countries have expressed a desire to move away fromdependence on the dollar. During last year’s BRICS summit, Brazil PresidentLuiz Inacio Lula da Silva called on the bloc to create a common currency for mutual trade and investment. He said a BRICS currency would"increase our payment options and reduce our vulnerabilities."
This could very well curdle the milk.
Central banks are already moving to diversify their assets andminimize their reliance on dollars. According to IMF data, the dollar made upabout 71 percent of foreign reserves in 1999. But by 2020, the percentage haddropped to 59 percent.
De-dollarization is happening for both economic and politicalreasons. First, other countries don’t want to be overexposed to a rapidlydepreciating asset. Second, they don’t want to put themselves in a positionwhere the U.S. can use the dollar as a foreign policy hammer.
Jessop points out that the trend has flattened since thepandemic, but it’s a bit deceiving due to recent dollar strength compared toother currencies. “Beneath the surface, though, the diversification out of USassets has continued,” he said.
We see this in consistent central bank gold buying. According to the World Gold Council, central banks net goldpurchases totaled 1,037 tons in 2023. It was the second straight year centralbanks added more than 1,000 tons to their total reserves.
China has led the way. The People's Bank of China has increasedits gold hoard for 17 straight months. China officially holds 2,262 tons ofgold. The Chinese have added over 300 tons of gold to their reserve since theyresumed reporting gold purchases in October 2022. And the country likely holdseven more gold off the books.
Exchanging dollars for gold represents a significant powershift. Some analysts speculate that the movement of gold from West to East could set the stage for a gold-backed currency that wouldchallenge dollar dominance.
Jessop concedes there might not be anything sinister going on.It could simply be a function of a shrewd PBOC investment strategy takingadvantage of gold’s strength. But he also points out “there may still be a lotmore to this story.”
“There are clear strategic advantages to China diversifying outof U.S. assets, largely given rising geopolitical tensions over Taiwan andBeijing’s growing assertiveness in the South China Sea … The switch to gold hashelped China build up a war chest safe from U.S. sanctions. Russia has alreadytaken this step, and other states may follow. China’s stockpiling of gold couldalso be a warning that the country could use its large holdings of U.S.government bonds as a weapon.”
The Telegraph recently published an article headlined “Xi Jinping’s vast gold war chest could let him takeTaiwan without a fight.”
In effect, the Chinese have “sanction-proofed” their economy orat least minimized the United States’ ability to use the dollar as a weaponagainst them.
China has also dumped a large number of U.S. Treasuries. The country’s Treasury holdings have fallen to their currentlevel of $775 billion from around $1.1 trillion in 2021. Chinese investment inU.S. debt hit a 14-year low in October.
Even so, China still holds a large amount of U.S. debt. AsJessop points out, “Any threat to dump these bonds could drive up the cost ofborrowing, not just in the US but also in the rest of the Western world.”
And borrowing costs are already straining the U.S. Treasury.
Rising interest rates drove Uncle Sam’s interest payments toover 35 percent as a percentage of total tax receipts in fiscal 2023. In otherwords, the government is already paying more than a third of the taxes itcollects on interest expenses, and those interest payments are rising everymonth.
The federal government spent $288.01 billion in interest expenseto finance the national debt in the first quarter of fiscal 2024. That was morethan national defense ($238 billion) and more than Medicare ($168 billion). Theonly higher spending category was Social Security at $351 billion.
And yet the borrowing and spending continues. As Jessop asserts,the United States is its own worst enemy.
“The recent strength of the economy and marketspartly reflects a massive fiscal stimulus begun under President Trump andcontinued
By Mke Maharrey
Mike Maharrey is a journalist and market analyst for MoneyMetals.com with over a decade of experience in precious metals. Heholds a BS in accounting from the University of Kentucky and a BA in journalismfrom the University of South Florida.
© 2024 Mike Maharrey - All Rights Reserved
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