Anthony Tarquinto argues that the incoming U.S. Secretary of State will try to keep ‘King Dollar’ on the throne –
One way or another – interest rates are going up. The Fed and/or markets will see to that. The dollar is going to be de-valued. The dollar vigilantes will see to that.
First – some history. In the early 1990s, so-called “bond vigilantes” threatened to sell U.S. government bonds in the face of exorbitant spending plans by the Clinton Administration that would have significantly increased the national debt. There were political repercussions.
From late 1993 to late 1994, the ten-year Treasury note climbed from roughly 5% to 8% in a selloff . That led to a Republican takeover of the House of Representatives, the first time in forty-two years. Clinton’s plans were halted because borrowing costs were too high.
Now America’s national debt is over 105% of Gross Domestic Product, much higher than in 1994. With no economic growth to speak of these past eight years, inflation has been subdued.
However – Trump’s planned tax cuts and regulatory reform will spur economic growth, but also fan inflation. A week after he was elected, the ICE U.S. dollar index hit its highest level since 2003. A month after the election, the dollar had strengthened 4.3% versus the Euro, and the recent 25 basis point hike by the Fed, while not much, can only make the dollar more attractive.
Despite all of this, though, the rally in the dollar is a mirage. The reason it has risen is because other currencies are so besieged. Great Britain is still sorting out Brexit, the Eurozone is mired in a banking crisis and Japan is in demographic deflationary decline. Even the vaunted franc is no longer a sure thing: deposit rates in Switzerland are negative. There is nowhere else to go.
DoubleLine Capital CEO Jeff Gundlach was the only upper-echelon money manager to predict a Trump victory. Last month he said – “the dollar is going down,”.
A dollar devaluation is long overdue. The last time it was officially de-valued was 1933. By executive fiat, Franklin D. Roosevelt ordered Americans to turn in all gold coins, which were redeemable at $20.67 an ounce. Roosevelt then bought gold on the open market, driving the price up to $35 an ounce, where it eventually stabilized. For those who handed in their coins it ultimately amounted to a 70% devaluation. To add insult to injury, those who did not turn in their coins had them confiscated.
For obvious reasons, a dollar devaluation today would not involve gold. It would be electronic, with Americans learning their new net worth by logging onto their bank’s website to see how many 1’s and 0’s they have left. In Cyprus, it was called it a “bail-in.”
In many regards, a nation’s bonds and the currency are one in the same. The recent troubles in the Europe bear this out. When a populist party in Europe gains momentum to leave the Eurozone, that nation’s debt sells off. Who would buy government bonds denominated in a currency that is going away? Greek bonds hit 12% in July 2015 as it teetered on the brink of leaving the Euro.
So, who are the dollar vigilantes?
They are nation-states that could lose faith in a currency that in recent memory was convertible into gold. For these purposes, OPEC is a nation-state. And who are the dollar vigilantes looking out for? Themselves mostly, but also emerging market nations that have borrowed in dollars but run into trouble when debts become more expensive to service in local currency terms. As it happens, countries like Argentina, Indonesia and Zimbabwe get suckered into International Monetary Fund loans and then are forced into default when the dollar strengthens. The IMF scoops up the collateral and the people get robbed.
IMF data show that in the last sixteen years, the dollar has dropped from 71% of foreign reserves to 61%, an orderly liquidation, but a decline nonetheless. The Chinese, the world’s largest holder of foreign currencies, has $3 trillion in reserve. But they had $4 trillion in June 2014, and drained $69 billion last November, no doubt to defend the yuan. Emerging markets are on the hook for over $200 billion in dollar-denominated loans and bonds due this year. When will the bottom fall out?
“The U.S. dollar is our currency, but your problem,” said Treasury Secretary John Connally at a conference in Rome shortly after Richard Nixon ended the Bretton Woods system in 1971. Nervous Europeans had no choice but to accept terms set forth by the administration that was protecting them from the Soviet Union. Yes, this was the same John Connally who while governor of Texas was sitting in the front seat of the limousine carrying John F. Kennedy on November 22, 1963 when the president was shot and killed. Connally was wounded but survived long enough to coordinate implementation of the petrodollar system, which required Gulf monarchies to price oil in dollars. This gave rise to the moniker “King Dollar.” With Rex Tillerson serving as America’s top diplomat, it might be another four years before the king is dethroned.