Opinion | As world adjusts to changing monetary regime, gold can serve as a hedge
PremiumGold still preserves its status as a payment instrument in world trade
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PremiumCurrencies of different countries have enjoyed reserve currency status for a cycle of nearly 100 years—the Portuguese from 1450-1530, the Spanish from 1530-1640, the Dutch from 1640-1720, the French from 1720 -1815, and the British from 1815-1920. Evidently, reserve currency status does not last forever. The US dollar has enjoyed dominant currency status since 1920. Having reached the end of the 100-year cycle, the question is: will this be true for the dollar too?
WHAT has happened?
Central banks have been stocking up on gold and diversifying their reserves away from the dollar, with Russia and China taking the lead. The share of the dollar in total central bank reserves has reduced from nearly 72% in 2001 to nearly 61% in Q3 2019, according to data from the International Monetary Fund (IMF). Further, usage of dollar in international payments has been declining. From a 45% share of global SWIFT payments in April 2015, the dollar’s share has declined to 38% as of April 2018. This means trade has started shifting away from the dollar and countries are using other currencies and bilateral trades for payments.
Why is that?
Most international trade is done in dollars and transactions are executed using US-controlled money transfer systems. Thus, when the US imposes sanctions on a country, even if other countries disagree, the US-based banks that those countries need to use for transacting won’t facilitate trading with the sanctioned country. As of 2019, the US has introduced sanctions against Venezuela, Iran, North Korea, Syria, Sudan and Cuba. With the US very often using this currency supremacy to weaponize trade by imposing sanctions on countries it wishes to “punish", there is growing sentiment to use national currencies and reduce dollar’s influence on economies and trade.
Also, with a galloping debt-to-GDP ratio of the US at 106.9% as of 2019 from 82.3% a decade ago, the world is slowly becoming aware of the fragile economic conditions on which the US economy stands. There are, thus, concerns that the trillions of dollars held by other countries could become worthless if dollar inflation sets in as a result of increased US deficit spending and printing of US Treasuries to support US debt.
HOW has the change come about?
INSTEX, a mechanism to facilitate non-dollar trade with Iran and avert US sanctions backed by the three largest economies of Europe along with China and Russia, became operational in 2019. Iran, Malaysia, Turkey and Qatar too have announced that they are considering a barter system and use of gold to trade among themselves and a counter-threat of US sanctions.
In 2018, the Turkish and Iranian central banks began to trade with each other in their local currencies. The year 2018 also saw the launch of the yuan-denominated oil futures—the first significant threat to petrodollar. This instrument, priced in yuan, indirectly promotes the use of the Chinese currency. In addition, China is escalating its de-dollarization scheme by seeking a bilateral rial-yuan agreement with Iran. Venezuela too in 2018 announced that it is abandoning the dollar, with all future transactions on the Venezuelan exchange market to be made in euros.
The Cross-border Interbank Payment System is a worldwide, interbank payment system rolled out by the People’s Bank of China. It facilitates the use of the renminbi globally and numbers using the system are widely expected to increase over time.
WHAT’s NEXT?
The dollar’s current number one status is definitely under contention. But the path ahead is far from defined. Maybe we can expect to see the international monetary system moving towards a multi-currency system where instruments like Special Drawing Rights (SDRs) play a dominant role. Or with countries such as China and Russia pushing for a new one-world currency which is not backed by any one nation, we could see the creation of a central bank-supported digital currency.
There is also talk about the dollar being replaced by another currency. But that seems unlikely. The euro makes up 20% of known central bank foreign currency reserves but the chances of it becoming a world currency have been damaged by the eurozone crisis which revealed the difficulties of a monetary union that’s guided by separate political entities. The yen and pound sterling, making up 5.6% and 4.4% of the central bank foreign currency reserves, respectively, are plagued with problems of their own. And in spite of China’s efforts to internationalize the yuan, it makes up only 2% of the central bank reserves currently. Thus, it seems like no currency is in a state to replace the dollar on an immediate basis and there is a high probability that any real alternative may revolve around the traditional currency—gold in some shape or form.
Any of the above shifts, though stretched over time, can be both de-stabilizing and dollar negative. Gold can serve as a hedge against both as it preserves its status as a payment instrument in world trade and reduces dependence on fiat currencies. Gold could, thus, become an asset of choice till the world adjusts to a changing monetary regime.
Chirag Mehta is senior fund manager, alternative investments, Quantum Mutual Fund
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