What does the rise in gold have to say about the fall in the dollar – 04/24/2023 – Market

Today, commentators overwhelmingly agree that the US dollar, although it is weakening, will not lose its position as the planet’s dominant currency, because there is “no alternative” visible on the horizon. It may be, but don’t tell that to the many countries that are rushing to find an alternative; that kind of complacency will only serve to speed up your search.

The main example right now is gold, which has accumulated a rise of more than 20% in six months. Growing demand is not led by the usual suspects — investors large and small, looking to hedge against inflation and low real interest rates. Instead, the heavy buyers are central banks, which are drastically reducing their dollar holdings and looking for a safe alternative. Central banks are buying more tons of gold now than at any time since data began to be compiled in 1950, and they now account for a record 33% of the world’s monthly demand for gold.

This buying boom helped push the price of gold to near-record levels and more than 50% higher than models based on real interest rates would suggest. Clearly, something new is driving gold prices.

If we take a closer look at buying central banks, 9 of the top 10 represent developing countries, including Russia, India and China. Not by chance, these three countries are in negotiations with Brazil and South Africa about the creation of a new currency to challenge the dollar. Their immediate objective: to trade directly with each other, in their own currency. “Every night I ask myself why do all countries have to base their trade on the dollar,” Brazilian President Luiz Inácio Lula da Silva said recently during a visit to China, arguing that an alternative would help “balance world geopolitics”. .

Thus, the oldest and most traditional of assets, gold, is now a vehicle for central bank revolt against the dollar. Often in the past, both the dollar and gold were seen as safe havens, but now gold is seen as much safer. During the short-lived March banking crisis, gold continued to rise while the dollar fell. The difference in movement between the two had never been greater.

And why are emerging nations rebelling now, when world trade has been based on the dollar since the end of World War II? Because the United States and its allies are increasingly turning to the use of financial sanctions as a weapon.

Surprisingly, 30% of all countries now face some form of sanction from the US, EU, Japan and UK — up from 10% in the early 1990s. Until recently, most targets were small. But then the group of countries mentioned above launched an open attack of sanctions against Russia for its invasion of Ukraine, excluding Russian banks from the dollar-based world payment system. It suddenly became clear that any nation could be targeted.

Relying too heavily on the indomitable dollar, the United States saw sanctions as a gratuitous way to fight Russia without risking the lives of its soldiers. But they are paying the price in terms of lost monetary loyalties. Nations striking deals to trade without using the dollar today include old US allies such as the Philippines and Thailand.

The number of countries whose central banks are studying ways to launch their own digital currencies has tripled since 2020, to more than 110, which account for 95% of the world’s GDP (Gross Domestic Product). Many of them are testing these digital currencies for use in bilateral trade — another open challenge to the dollar.

While some doubt that a dominant dollar is important to the US economy, the heightened demand for the US dollar in general tends to lower the cost of borrowing abroad, a perk the US needs today. Among the top 20 developed economies, the country now has the second-largest fiscal and current-account deficit, behind the UK, and the second-largest foreign liabilities (as reflected by its net international investment position), behind Portugal.

The risk for the United States is that its overconfidence will grow, fueled by the “there is no alternative” story. That narrative depends on the world’s trust in American institutions and the rule of law, but that is exactly what the weaponization of the dollar has done much to undermine. It also hinges on confidence in the country’s ability to service its debts, but that too is beginning to be called into question as America’s reliance on foreign financing continues to grow. The dollar’s last line of defense is the plight of China, the only economy large and centralized enough to challenge the supremacy of the US currency — but which is even more deeply indebted and institutionally dysfunctional.

When a giant comes to depend on the weakness of its rivals, it’s time to look closely in the mirror. When a “barbaric relic” like gold and new competitors like digital currencies present challenges, the giant should look for ways to bolster confidence in its finances, and never assume that its status as a financial superpower is unshakable.