Upcoming Monetary War

I came across an interesting article from the folks at GaveKal Research entitled "The Upcoming Monetary War, with Gold as an Arbiter". (I posted another article from GaveKal Research last week on the website. Special thanks to Charles Gave who gave permission to share). This is the second article and it is well worth a read. Charles Gave discusses the potential for conflict between the US and China, but he cogently argues that the fight will be less about trade and more about the struggle for dominance between the US dollar and the renmimbi. 

Any currency has three basic functions: it should be a medium of exchange, a unit of account and a store of value. To be elevated to reserve currency status it must also be fully convertible and accessible at any time without constraint. The nation controlling such a currency should control the sea lanes and have the largest financial market, such that in times of stress it can lend money to others. It should be technologically dominant, so that it has the best weapons and runs the highest margin businesses. It should also be a cultural power, such that it educates the children of the global elites. It also helps to be dominant in agriculture. On this score card, the US dollar is starting to face certain problems...
— Charles Gave, GaveKal Research

Gave argues that since the 9/11 attacks, the US has pulled back on allowing unconstrained global access to the USD. The US is exerting its power to freeze assets of certain misbehaving countries (Iran, Russia), while only allowing the well-behaved access to USD reserves. This is a dangerous game the US is playing, particularly given the trajectory of ever-increasing US budget deficits in the years ahead, which will need to be financed. China seems set on de-dollarizing the world according to Gave. China has recently offered renmimbi swap lines to multiple central banks, so as to provide emergency lending in times of crisis. China has also recently launched crude oil (and gold) futures contracts traded in renmimbi. Gave notes that China is planning to become the world's biggest financial market by 2047, when Hong Kong reverts to mainland control, with Singapore playing a complimentary role, just as London has in recent decades to New York.

Now, most people tell me that the renminbi cannot become a global currency as it has a closed capital account. The answer to that objection is simple: China has just to offer a conversion in gold to anybody who has too many renminbi. And indeed it is headed in that direction. In recent years the Chinese have bought all the gold they can lay their hands on, as have the Russians. So, the real economic struggle between the US and China may not be fought out over trade or technology, but end up as a monetary war. In this regard, watch gold as any significant rise in its price versus the US bond market will be a defeat for Washington; any fall in this ratio should be seen as a victory. In recent years we have been in a stalemate. I doubt that this situation will last.
— Charles Gave, GaveKal Research
 
Gold vs Zeros.jpg
 

The performance of gold priced in USD versus US long duration zero coupon bonds suddenly became a lot more interesting. As Charles notes, in recent years, we have been in a stalemate, but he doubts that situation will last much longer. I hold a similar view.

 

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