Gold, Bitcoin Rallies Signal A Big Dollar Problem

“In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues, Moody's expects that the US' fiscal deficits will remain very large, significantly weakening debt affordability,” Moody's analysts said.

That's led to firm pushback from Washington.“We disagree with the shift to a negative outlook,” Deputy Secretary of the Treasury Wally Adeyemo said last month.“The American economy remains
strong and Treasury securities are
the world's preeminent safe and liquid asset.”

Not if global central banks decide otherwise. Asia's 10 biggest currency reserve-hoarding institutions hold more than $3.2 trillion of US Treasuries. Tokyo is the biggest with $1.1 trillion of exposure that must be causing sleepless nights at the Bank of Japan.

Beijing, Washington's No 2 banker, has been working to reduce its dollar exposure. As of early November, China's US government debt holdings were down about 40% over the last decade. With just over $860 billion of Treasuries, China's growing aversion to the dollar is raising eyebrows in government offices and trading pits worldwide.

So is a new powerful gold rally that has pushed spot prices above $2,100 for the first time. There are a few popularly accepted explanations for the dollar's drop, with most centering on bets the Fed's next move will be to cut rates or that geopolitical tensions will dangerously intensify in 2024.

“The expectations of the end of the tightening cycle have been priced in, pushing longer-term yields lower,” says Daria Efanova, head of research at broker Sucden Financial.“This has created a more favorable environment for gold as a non-yielding asset.”

Yet things might not be so favorable for Asia if the dollar's stumble unfolds in disorderly ways. Indeed, if the deep sense of global unease doesn't benefit the dollar, more investors might turn against it.

As top US bankers like JPMorgan Chase CEO Jamie Dimon warn, the global economy is now navigating the most dangerous set of risks in several decades.

Dimon's not alone in that outlook.“The geopolitical risk environment appears to have changed,” World Gold Council strategist John Reade told CNN.“Not just because of Russia invading Ukraine, not just the terrible things going on in Israel and Gaza, but trade tensions between the US and China , concerns about what will happen in the South China Sea, concerns about what China will do in Taiwan.”

Victoria Scholar, head of investment at Interactive Investor, adds that“concerns about the shaky global economic backdrop and the Israel-Hamas conflict have fueled investor demand for safe-haven assets like gold. Plus, expectations for Fed rate cuts next year have put downward pressure on the US dollar, adding to gold's attractiveness.”

Yet Fed expectations don't tell the full story. Economists at Goldman Sachs, for example, characterize the level of US monetary easing now being priced in by financial markets as“excessive.”

In a recent report, Deutsche Bank detailed six episodes over the last two years when markets decided the Fed's rate hike cycle was ending – only for rate hikes to continue.

Those events include the Omicron variant scare of November 2021; Russia's Ukraine invasion in February 2022; fallout from China's pandemic lockdowns; global recession fears in July 2022; England's debt chaos in the autumn of 2022; and Silicon Valley Bank's collapse in March 2023.

These projected pivots proved wrong every time as Fed Chairman Jerome Powell's team continued to crank up rates.

“As inflation begins falling, the debate increasingly turns to the risk of over-tightening and whether policy risks are being too restrictive,” Deutsche Bank argues.“It's difficult to know the answer in real-time since monetary policy operates with a lag. So, with markets pricing a pivot for a seventh time, it's worth considering whether the conditions are actually in place for that to happen.”

As Deutsche Bank strategist Henry Allen puts it:“Clearly it's possible that this time could be different and the rise in unemployment and the fall in inflation is putting us closer to a position where the Fed has begun to cut rates in previous cycles. But 2023 has shown how expectations for cuts have been repeatedly pushed into the future.”

Might the
Israel-Hamas crisis
lead to a broader conflict in the Middle East that sends oil prices skyward? Could Saudi Arabia's push to reduce OPEC+ production gain traction? What if Russian leader Vladimir Putin intensified his military campaign in Ukraine, boosting both energy and food costs?

There's also the risk that US-China trade tensions worsen in ways that inflame inflation. Perhaps the only thing on which US President Joe Biden's Democratic Party and Republicans loyal to former president Donald Trump agree is on hobbling China's economic rise.

Political brawls ahead of the November 2024 election could mean additional sanctions on China that upend supply chains, boosting global inflation anew.

“Our base case is for a recovery in the dollar into year-end,” says Elsa Lignos, head of currency strategy at RBC Capital Markets.“The dollar remains the highest yielder in the G-10 and higher-yielding than several emerging markets.”

Analysts at ANZ Bank add that“we therefore expect that the Fed, while encouraged by recent inflation improvements, will continue to adopt a hawkish policy stance.”

But gold's bull run – as well as the new rise in cryptocurrencies – suggests that America's finances coupled with extreme political tribalism in Washington are the bigger worry.

One dubious 2023 milestone: Washington's national debt racing past the $33 trillion mark. The costs of this widening fiscal imbalance are rising fast.

At the end of October, the US government's estimated annualized debt interest payments topped $1 trillion. That represents a doubling of Washington's payments burden over just the last 19 months, equivalent to roughly 16% of the entire federal budget for fiscal year 2022.

Sign up for one of our free newsletters

• The Daily Report Start your day right with Asia Times' top stories
• AT Weekly Report A weekly roundup of Asia Times' most-read stories

In a recent report, Bloomberg Intelligence analysts argued that“this high proportion of interest payments as a share of federal spending has precedent, as the portion before 2000 was over 14% in most years. The challenge for the government is tempering mandatory spending and trying to reduce the need to issue more debt. That's the reason we see interest payments climbing even though we forecast lower Treasury yields .”

The dollar's days as world's reserve currency could be numbered. Image: Twitter / Screengrab

If yields continue to surge, fiscal pressures will reverberate through the halls of power in Washington. This also would make for high drama every time the Treasury Department holds a debt auction, hoping bidders show up. That's especially true of Asia's central banks and finance ministries.

It's here where US political polarization makes for quite the 2024 wildcard. To be sure, the Powell Fed's 11 rate hikes over the last 18 months jacked up America's borrowing costs. But now concerns about how political clashes might damage trust in the dollar will take centerstage.

Such fears hit a fever pitch after Fitch Ratings' August 1 move to downgrade the US to AA+ from AAA. At the time, Fitch cited both a“deterioration” in US finances and the“erosion of governance” as lawmakers played games with the debt ceiling and threatened to shut down the government.

Fitch's action has global markets“focusing on the deficit issue” as never before, says Ed Yardeni, president of Yardeni Research. He notes that if inflation remains“sticky,” the US Treasury Department could have a“bond vigilantes” problem on its hands. That, he adds, could prod politicians to do“something more fundamental” about reducing the deficit in the longer run.

Yet extreme polarization in Washington makes that highly unlikely. The same goes for the Biden-Trump tussles to come. Already, some of Biden's policies have run afoul of currency traders, from profligate spending to limiting China's access to vital technology to“weaponizing” the dollar in Washington's brawl with Moscow over Ukraine.

The specter of a Trump 2.0 presidency presents its own risks, including the likelihood he would escalate trade wars with China and beyond. Trump's team famously mulled canceling portions of US debt held by Beijing in his first term. He also browbeat the Fed into easing in unseemly ways in 2019, denting Powell's reputation for independence.

Add in China's efforts to internationalize the yuan in the Xi era and there's ample reason to think the dollar's credibility troubles have only just begun, as the rallies underway in gold and Bitcoin indicate.

Follow William Pesek on X, formerly Twitter, at @WilliamPesek

Like this:Like Loading...