By Nicole Goodkind, CNN Business
(CNN) — The United States may have the most powerful military in the world, but the dollar is its greatest weapon. Today, after nearly 80 years of dollar dominance, the United States is in danger of losing its status as the world’s reserve currency.
About 60% of the world’s $12.8 trillion in foreign exchange reserves are currently held in dollars, giving the United States an exorbitant privilege over other countries. And this privilege pays off: as US public debt backed by the dollar is very attractive, interest rates are lower. The US can borrow from other countries in its own currency – so if the US dollar loses value, so does the debt. US businesses can transact internationally in dollars without having to pay conversion fees.
Perhaps more importantly, in extreme circumstances the United States can cut off access to the dollar from central banks around the world, isolating and depleting its economies. Raghuram Rajan, the former governor of the Reserve Bank of India describes this power as an “economic weapon of mass destruction”.
The United States detonated that weapon against Russia in February after the country invaded Ukraine, freezing $630 billion in foreign exchange reserves and deeply undermining the value of the rouble. This gave America the ability to punish Russia without involving American troops in the war.
But with great power comes great responsibility: when you use a weapon of mass destruction, even an economic one, people get scared. To protect themselves from the same fate as Russia, other countries are diversifying their investments away from the US dollar into other currencies.
This is where the country’s reserve currency status could run into trouble.
Arming the dollar, said Michael Hartnett of Bank of America strategists, could lead to its debasement. The “balkanization of global financial systems” is eroding America’s role as a reserve currency, he added.
A new research paper from the International Monetary Fund has found that the dollar’s share of international reserves has declined over the past two decades, around the same time the United States began its war on terror and sanctions. against terrorism. A quarter of reserves have since moved from the dollar to the Chinese yuan, and the other three quarters have moved to the currencies of smaller countries.
“These observations provide insights into how the international system may evolve in the future,” warned the paper’s co-authors, Serkan Arslanalp of the IMF, Barry Eichengreen of the University of California at Berkeley, and Chima Simpson. – Bell also from the IMF.
Russia and China also hope to guide the evolution of the international system.
Russian President Vladimir Putin on Thursday threatened to end gas exports to countries that do not open an account in a Russian bank and pay in rubles. The European Union gets about 40% of its gas and 30% of its oil from Russia with no easy alternative.
Saudi Arabia, meanwhile, is in talks with Beijing to accept yuan instead of dollars for Chinese oil sales.
So, is the king of the dollar about to be dethroned?
If the past two years have taught us anything, it’s that nothing is impossible. But the prospect of the United States losing this exorbitant privilege is highly unlikely.
For one, the alternatives aren’t great. China has been pushing the yuan for years and only around 3% of global transactions are conducted in this currency, compared to 40% for the dollar.
The United States is also still quite attractive to the rest of the world. The US stock market is the largest and most liquid stock market in the world, and foreign capital is flowing into the country. Global flows of foreign direct investment increased 77% to around $1.65 trillion in 2021, but investments in the United States soared 114% to $323 billion, according to the United Nations Conference on trade and development.
Goodbye Q1, hello Q2!
The second quarter might not be fun, but at least we’ll be prepared for it.
The rollercoaster first quarter of 2022 ended bitterly this week, with major equity indices posting their worst performance in two years. Soaring inflation, Russia’s invasion of Ukraine and the acceleration of the Federal Reserve’s rate hike plan have created a series of unique challenges for investors.
These challenges will continue into the second quarter. But often the devil you know is better than the devil you don’t know.
We asked analysts what they think will be the biggest headwinds this quarter and how they are preparing for them. Here’s what we found.
Geopolitical unrest: Russia’s invasion of Ukraine stunned markets around the world. Geopolitical unrest has spilled over into energy markets, commodities and even food insecurity issues.
Josh Leonardi, director of blue chip services at TD Securities, is looking to commodity markets, where raw products are sold, to hedge against the Russian conflict. He particularly likes wheat. About a quarter of the world’s wheat supply comes from Russia and Ukraine. Future contracts for the crop explode as supply dwindles but demand remains the same.
It’s probably best not to bet on oil and energy, as these commodities have been particularly volatile and reactive to news updates.
Inflation: The United States currently has an inflation problem the likes of which it hasn’t seen in 40 years, so it’s time to turn to real assets as an inflation hedge, Leonardi said. This means investing in raw materials, real estate, land, equipment and natural resources.
Interest in real estate investing is exploding, he said. “I don’t know if anything is hotter in the market right now. You have everything from single and multi-family homes to data centers to cold storage.”
When investing in the markets, look for companies that make money from spikes in inflation. Banks earn more as interest rates rise and they profit from wider spreads. Companies with low capital requirements are also good bets.
Price increase: The Federal Reserve is likely to be aggressive in raising interest rates going forward, said Liz Anne Sonders, managing director and chief investment strategist at Charles Schwab.
Typically, investors believe in a security guard known as the “Fed Put.” It’s the idea that enough market weakness will prompt the Fed to stop raising interest rates and tighten policy, and perhaps even reverse and ease rates. Because inflation is so out of control, there’s no way it’s happening this time around, Sonders said.
“Investors need to be aware of this, especially if they are more aggressive because they think the Fed won’t let the markets down,” Sonders said. They will continue to raise rates and will do so to slow economic growth. This means that the risk of recession is higher than it otherwise would be.
following
Monday: March U.S. Motor Vehicle Sales Released by BLS; The Main Street Sentiment Investor Movement Index released by TD Ameritrade
Tuesday: New York Fed President John Williams talks about the economy
Wednesday: FOMC minutes released at 2 p.m. ET
Thusday: Published weekly jobless claims
Friday: Eli Lilly announces its earnings before the bell
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