Banking

Who might get stranded by US currency risk?

They want to put America back to work and this doctrine is the way to go.

It is Keynesian with the addition of seigniorage and is compelling for our times.

Seigniorage is government profit made from issuing currency, especially the difference between the face value of notes and coins and their production costs – that is, the benefit that accrues to the money issuer which currency holders bestow by not receiving interest on their holdings.

Ever since President Nixon suspended gold convertibility 50 years ago, the dollar has depended on the kindness of strangers to support its value.

Consequently, there have been persistent fears of its collapse, but stories of its death have always turned out to be exaggerated.

Indeed, if we look at its nadir, in the spring of 2008, the low is solid, just 24% below today’s value.

That is not to say its purchasing power has held up, just that it has gone down no faster than everything else despite the monstrous deficit financing that continues as much as ever.

What if seigniorage is underrated and everyone is looking the wrong way?

What if the Chinese are not going to get fed up and dump their trillions of bonds?

The picture has been painted a thousand times, yet however much the US abuses its privilege, everyone still wants to hold dollars.

On the other hand, during troubled times, people run to the dollar and it remains the ultimate risk-off asset.

Other currencies can crash and burn.

The dollar: not so much.

And because of seigniorage, all these deficit dollars are financed at lower interest rates than would be warranted by comparable economies pulling the same stunt.

The lower interest rate on the dollar creates temptation.

Human nature is anchored in short-term dissonance and so it is no surprise that time and again, when the dollar rises, we see the dollar borrowers go down in flames.

1982 saw off Mexico who had borrowed against oil revenues; which collapsed.

The 1987 crash got Turkey, whose currency and stockmarket collapsed together.

Black Wednesday in 1992 punished UK individuals who had listened to siren voices to re-mortgage in dollars or Swiss francs as the pound crashed out of the ERM.

The Asian crisis of 1997 just kept rolling on through the emerging countries, felling another domino each time hope was rising from the ashes.

The common thread of the borrowers: hope for a brighter future, based on prospects which seemed to justify stepping on the accelerator.

What now? We know the store of value is as strong as ever: the dollar spiked up in March 2020 as the world economy hit the wall.

We also know bondholders are putting up with the most negative real interest rates since the 1970s with the CPI at 5.4% and the 10-year bond yielding 1.3%.

What is the Chinese threshold of pain that would make them sell?

Not here, evidently.

Despite the integrity of gold or crypto, dollar seigniorage is more powerful than ever and the Democrats know it.

If the infrastructure plan gets a boom going or fear causes risk-off, overseas dollar borrowers will hurt.

Who is borrowing more cheaply than local rates to profit from good returns available?

Who has not done it before? Africa?

We do not know but it is worth bearing in mind because when the unravelling starts, it always hurts more than expected.

Richard de Lisle is fund manager of the VT De Lisle America fund

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