Preamble
In my opinion, a failure to effectively handle difficulties such as the banking crisis and de-dollarization will certainly light the blue touch paper under the price of SPDR Gold Shares ETF (NYSEARCA:GLD), but the effect on those who don’t hold assets such as GLD will be a life of penury.
De-dollarization
It is important to note that de-dollarization could potentially have a significant impact on inflation in the US. Clearly, a decline in demand for US dollars internationally will lead to a lower USD, which in turn will result in higher prices for imported goods and services. And gold bugs need no reminding that GLD is an option often chosen in inflationary times to protect purchasing power.
In addition, de-dollarization will also impact US monetary policy. If the US dollar is no longer the dominant international currency, the Federal Reserve may have less control over global interest rates, which could limit its ability to control inflation domestically.
In a previous article, I outlined the reasons why de-dollarization could also lead to a fall in demand for US Treasuries. If this happens to any significant extent, borrowers may expect interest rates to rise, conceivably leading to higher inflation.
However, it is important to appreciate that de-dollarization is a complex process and depends on the pace and manner in which the transition occurs, as well as the extent to which other currencies and assets are able to effectively replace the US dollar. In only the last month, we have seen that the pace at which the dollar is being substituted is rapidly gaining momentum.
Malaysia Prime Minister, Datuk Seri Anwar Ibrahim, on a recent visit to China stressed the need to forego the use of the dollar and the reliance on the International Monetary Fund. He also confirmed that “Malaysia’s central bank is already working on enabling the two nations to negotiate on trade matters using the ringgit and yuan.” This announcement comes hot on the heels of actions taken by India to allow trade between the two nations to be settled in Ringgit and Rupee as from this month.
In fact, recent reports suggest that Indian Rupee is now going global as up to 18 countries have already agreed to trade in Rupee. Now traders will be able to import goods from India by paying in Rupee rather than settle in USD.
One can understand countries outside of the collective West taking tentative steps to move away from the dollar, but we now have an instance of a close ally paying for hydrocarbons in Yuan. At the end of March, according to Reuters, French oil and gas giant Total Energies completed a yuan-settled LNG trade via the Shanghai Petroleum and Natural Gas Exchange.
There are many other examples of bilateral trade agreements I could list, but the above ought to indicate which way the wind is blowing.
The US government’s response
One of the ways in which the US government promotes the use of the dollar is through economic diplomacy. This involves encouraging other countries to use the dollar for trade and investment by negotiating trade deals, offering financial assistance, and promoting the use of the dollar in international organizations like the International Monetary Fund and the World Bank.
An example of this was the recent dispatch of the big kahuna, Kamala Harris, to Africa. Whilst there, she certainly splashed the cash in an effort to garner support for the USD.
Other ways in which the US government combats de-dollarization is through financial regulations and the use of sanctions to discourage countries from de-dollarizing. Sanctions can be imposed on countries that attempt to switch away from the dollar, making it difficult for them to transact in international trade and finance, which of course can be a powerful deterrent for countries considering such a move.
One can well imagine a limited use of sanctions to browbeat countries into sticking with the dollar would be effective. However, when 25% of the world’s population are sanctioned, I would argue that sanctions have the opposite effect. Afterall, if countries are unable to use the dollar, what are they to do?
To sum up, many countries are in the process shifting their allegiance from the dollar to alternatives. In part, the reason for this is due to excessive use of sanctions by the government. As a result, the price of physical gold and GLD are likely to likely to head north moving forward.
The banking crisis
In an article I wrote on the 18th February, I forecast an imminent banking crisis. In the piece, I advised readers; “Investors may wish to err on the side of caution and review their investments in the banking sector.” Since then, many banking stocks have tanked. For instance, BANK, the NASDAQ Combined Bank Index is down approximately 25%. It is my belief that there is further turbulence ahead for this segment of the economy.
I don’t propose to rehash my previous article but instead focus on one item I gave a couple of lines to, and that is the trillions of dollars of loans and leases that banks have on their balance sheet.
As is readily appreciated, the decline in value of commercial office space can have a significant impact on banks, particularly those that hold large amounts of commercial real estate loans on their balance sheets.
As the value of commercial office space declines, the collateral backing these loans may become less valuable, potentially leading to a higher risk of default. This can result in loan losses for banks, which can then impact their profitability and overall financial health. As we can appreciate, declining property values can make it more difficult for borrowers to refinance or sell their properties, leading to a further increase the risk of default.
Moreover, declining property values can also impact the quality of banks’ existing loan portfolios. If borrowers experience financial difficulties or default on their loans, banks may need to increase their loan loss provisions, which can impact their profitability.
A simple search will reveal any number of scary news items on the subject of commercial real estate. For instance, we can read that an office landlord defaulted on seven office buildings in California, New York and New Jersey. Or that Brookfield chose to default on loans on two buildings due to weak demand for office space. However, for this piece I would like to draw your attention to a Morgan Stanley report that was released a few days ago. Top of Form
In the report, Morgan Stanley forecasts that commercial real estate prices could fall as much as 40%, similar to the fall experienced at the height of the 2008 financial crisis. Naturally, if this happens, a banking crisis of epic proportions is likely to ensue.
The big question is that if this doomsday scenario comes to pass, what will the government / FED do about it? Who knows? Maybe print more money, allow banks to fail, reduce interest rates or maybe activate bail in laws which means that the customers of banks pay for a bank rescue. It seems to me that whatever happens in this situation, the price of GLD will move higher. But, once again, those that do not own hard assets will be badly affected.
Summary
On the issues highlighted, it is up to individuals to draw their own conclusions, however, it is hard to argue that the excessive use of sanctions has been a tail wind for de-dollarization, and so given GLD a boost. It is also fair to say that banks have further challenges to face near term, and whatever solution is found for these problems, its more than plausible that an upward move in the price of GLD will be the result.
As always, this does not constitute advice and investors ought to carry out their own due diligence.
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