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Could This Terminate the Reign of the U.S. Dollar? Lombardi Letter 2018-10-04 09:20:34 us china trade war tariffs european central bank federal reserve hegemony yuan petroyuan us dollar chinese yuan trump trade war china The global power of the U.S. dollar has allowed the United States to build its economic and geopolitical might. A weaker dollar will effectively erode America’s influence. Analysis and Predictions 2018,News,Stock Market,Stock Market Crash,U.S. Dollar,U.S. Economy,U.S. Politics,World Politics https://www.lombardiletter.com/wp-content/uploads/2018/09/US-dollar-vs-Chinese-Yuan-150x150.jpg

Could This Terminate the Reign of the U.S. Dollar?

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Trump’s Trade War on China Threatens the U.S. Dollar

The tensions that President Donald Trump has unleashed between China and the United States could last decades, threatening the hegemony of the U.S. dollar. The risks don’t merely affect trade, business, and tariffs.

China—whether in 10, 15, or 20 years—will inevitably surpass the United States in economic strength. Some analysts believe that, by 2032, the largest economies in the world will all be in Asia, led by China. (Source: “China to Overtake U.S. Economy by 2032 as Asian Might Builds,” Bloomberg, December 25, 2017.)

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The issues of tariffs and trade will, inevitably, turn in China’s favor. But that’s not the most important aspect of the forthcoming shift in the global economic hierarchy.

What should cause American investors more concern is the status of the U.S. dollar. The global power of the dollar has allowed the United States to build its economic, geopolitical, and military might.

A weaker dollar will effectively erode America’s influence. It happens with all empires, political or economic, eventually.

The most recent swing in that context occurred when the dollar definitively unseated the British pound after World War II. That was as Great Britain steadily relinquished its empire, which merely three decades earlier had been the world’s largest.

The United States Can Literally Create Money

Whenever the U.S. needs to, it prints more dollars, which allows the country to recover from financial crises (such as the one in 2008) faster than others.

The Europeans are less able to maneuver in crisis situations. They relinquished their financial sovereignty to the European Central Bank (ECB), which enforces tighter fiscal controls.

By being able to print more dollars when necessary, running huge deficits and accumulating more debt, the U.S. can sustain its mighty military machine around the world. It’s thanks to the dollar that Trump and his predecessors at the White House could keep boosting military spending to record-high levels.

And it’s thanks to the fact that all countries buy key resources—from oil to potash, to steel, to soybeans—in dollars. The U.S. dollar (for now) is always in demand; it’s the prom queen of currencies.

As China Grows, the Yuan Will Replace the Dollar

The process of the yuan replacing the dollar will accelerate as Washington pursues short-sighted foreign policy goals, such as enforcing sanctions on an ever-growing list of countries—including Russia and Iran—as well as the companies and states that do business with them.

Eventually, that strategy—which Trump (but not only him) has been pursuing with maniacal dedication—will backfire.

Indeed, the best way to avoid running into the limits imposed by sanctions—by Japan, China, or any other country wanting to buy Iranian oil (an activity banned by the sanctions), for example—would be to use a currency other than the U.S. dollar.

The idea that the yuan could be that currency is hardly new. The faster the U.S. creates incentives for others to stop using the dollar for international trade transactions, the faster the yuan will replace it. (Source: “China to Cancel Talks If Trump Moves Ahead With Tariffs, Sources Say,” Bloomberg, September 17, 2018.)

If the rise of the petro-yuan is in the long-term future, the trade tensions between Washington and Beijing are becoming more worrying now.

Consequences of the Tariff Spat Will Be Swift and Harsh

The tensions over trade, at best, will produce a “win the battle, lose the war” scenario.

There are no assurances that whoever succeeds Trump at the White House will continue along the same path. Thus, the long-term effects for the United States are at best uncertain.

The prospects for relations between the U.S. and China are those of deterioration, escalation of tariff spats, and retaliation. That’s no good for anyone.

If Wall Street welcomed Trump’s victory in the 2016 presidential election—and Trump’s corporate tax cuts in particular—they could soon regret that enthusiasm over the next few months.

And that’s because Trump’s tariff wars with China and the European Union (EU) have the greatest potential to explode the inflating bubble on Wall Street.

If we haven’t seen the effects of the trade war yet, it’s because most investors and analysts—myself included—considered Trump’s menacing words to be nothing more than a negotiating tactic, as described in his book The Art of the Deal.

Trump’s goal, many believe, consists of forcing his hand in order to achieve a more favorable trade arrangement with China and the EU.

Still, the events of the past few weeks suggest that the tactic has started to overstretch itself.

China Will Not Play Trump’s Game 

Beijing had already started to build new commercial and diplomatic bridges (and literal railways and other routes) with its neighbor Russia, speeding up the process of moving away from the dollar and a reliance on surplus trade with the United States.

In other words, Trump’s trade wars are isolating the United States.

That would not be a bad thing if Washington remained in control of the process, but Washington has lost control of it by pursuing an adamant anti-Russia and anti-Iran diplomatic strategy. Doing so has forced foe and ally alike to start looking for alternative partnerships.

Thus, now it’s more of a situation of the United States becoming more independent from the world than it is of the world becoming more independent from the United States.

Just recently, the U.S. added 10% tariffs on some $200.0 billion worth of Chinese goods. It’s a dangerous move, not only because of the immediate effects on the price of the goods for American consumers and businesses. Rather, this could trigger a broader confrontation, with potential geopolitical and military developments.

Effects on the World Economy Could Be Devastating 

Beijing has appealed to the World Trade Organization (WTO) while also retaliating with counter-duties for $60.0 billion worth of U.S. products, including industrial components, chemicals, and medical equipment.

At this point, it seems unlikely that Trump and Xi Jinping, China’s president, will resume any kind of dialogue to soften the situation.

Trump is playing hardball ahead of the November mid-term elections. He can’t back down.

China is playing a longer game. Not only will Xi Jinping not back down, but he may not resume talks if and when Trump decides he has pushed the trade war as far as he can.

And here’s how the trade war will affect investors and consumers alike, even if the markets continue to ignore the problem. Higher tariffs will make many products much more expensive ahead of the peak American shopping season.

U.S. retailers, from Walmart Inc (NYSE:WMT) to Amazon.com, Inc. (NASDAQ:AMZN), which have built empires on selling cheap Chinese-made goods, will no longer be able to exploit margins in order to attract customers during special sale events like Black Friday and Amazon Prime Day.

The problem, as Trump sees it, is that China enjoys a trade surplus of some $370.0 billion vis-à-vis the United States.

But Trump is thinking like a CEO rather than a president. For a CEO, a deficit like that spells trouble, but for an overall economy, the trade deficit has little to do with the country’s overall economic health. The availability of cheap goods has stimulated the U.S. service economy.

As desirable as a return of higher-paying industrial jobs is, Trump would achieve better results by targeting the all-American corporations that resorted to outsourcing in the first place—while steering Washington’s relationship with Beijing toward greater international cooperation.

The Reason for This Should Be Obvious

Rather than retaliating with counter-tariffs, Beijing can resort to what some have described as the “nuclear option.”

It has nothing to do with rockets or bombs (for now). Instead, it has to with U.S. debt. China owns almost $1.2 trillion of U.S. debt in the form of Treasuries. (Source: “China’s $1.2 trillion weapon that could be used in a trade war with the US,” CNBC, April 6, 2018.)

And China could simply decide to get rid of it, lowering the value of the U.S. dollar. That would encourage other holders of U.S. debt (like Japan)—also angered by trade tariffs—to do likewise.

China’s continuous purchasing of U.S. Treasuries has allowed the policy of quantitative easing, which has fueled Wall Street since 2009.

Even a reduction in China’s purchasing of Treasuries would trigger a crash of the bond market. Not to mention, recession-like effects on the overall economy would result from the Federal Reserve’s inevitable sharp hike in interest rates.

The only thing holding back Beijing from selling its Treasury holdings is the interest it earns every year.

But if Trump’s push becomes shove, the Treasury bomb might be China’s best option.

Editor’s Note: Hi, Alessandro Bruno here. If you enjoyed this article, you can get more of my opinions and commentaries in our popular newsletter, Lombardi Letter. Published daily, it’s FREE! Join us when you click here now.

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