Signs of A Cracking Dollar Hegemony

The US dollar has been functioning as the world reserve currency for several decades. However, its strength has been fading over the years. As we wrote in Research Shows ALL Paper Money Systems Failed, when the tie between the dollar and gold had been removed by President Nixon, he clearly stated: “Your dollar will be worth just as much tomorrow as it is today. The effect of this action is to stabilize the dollar.” Looking at the long term chart of the value of the dollar, it seems that those words were to be taken very, very literally. Since then, the dollar has been in a waterfall decline.

Although a world reserve currency does not give away easily, there are certainly enough signs of a structural change. Not only are the number of signs increasing, they are also becoming more structural. 2014 is probably not yet the year in which a dollar collapse will play out; it will for sure be a year in which we can expect a continuation of this deteriorating pattern.

The most important evolution lately is the increased effort from China to back away from the dollar. The Chinese are doing so in two different ways. First, the yuan is increasingly being used as the currency of exchange in trading agreements. Second, the People Bank of China is decreasing its dollar holdings.

Apart from that, the tensions between the US and Saudi Arabia are increasing. The importance of this is directly related to the petrodollar system, in which Saudi Arabia plays a fundamental role.

Yuan gaining importance as a trade currency

The Wall Street Journal had it spot on. In their newspaper of 12/4/13, an article stated that “very quietly, the use of the Chinese yuan in trade finance has overtaken the Euro and the yen, making the yuan the second-most used currency in trade finance.”

Moreover, the Shanghai Futures Exchange is preparing to price its crude oil futures contracts in yuan. According to Reuters, China overtook the United States as the world’s top oil importer in September and aims to make the yuan traded oil contract the benchmark in Asia. “China is the only country in the world that is a major crude producer, consumer and importer. It has all the necessary conditions to establish a successful crude oil futures contract.”

The People’s Bank of China is supporting these developments with adaptive monetary policies. Their policy makers recently made clear they will rein in dollar purchases that limit the yuan’s appreciation. The foreign-exchange reserves from China rose to $3.66 trillion in the third quarter of last year. That is a staggering amount, knowing that a major part of those holdings is in US dollars. “China’s holdings of Treasuries increased by $25.7 billion, or 2%, to $1.294 trillion in September, the biggest gain since February.” The Chinese central bank is committed to have less intervention and smaller gains in foreign-exchange reserves which does not bode well for dollar denominated US government debt. Source: Bloomberg.

Obviously the US is responding to this threat, as Finian Cunningham from Press TV explained. Recent military tensions between the two countries in the East China Sea is superficially over China’s unilateral declaration of an air defense zone. “But the real reason for Washington’s ire is the recent Chinese announcement that it is planning to reduce its holdings of the US dollar,” he wrote.

Tensions between Saudi Arabia and the US

The petrodollar system is one of the most important indicators to watch in order to gauge the timing of the collapse of the US dollar. According to Jim Rickardsthe petrodollar system is now collapsing for two reasons:

The US has abused its privileged reserve currency position by printing trillions of dollars in an effort to create inflation. More recently, President Obama has taken steps to anoint Iran as the regional hegemon of the Middle East, and to ease the way, in stages, toward Iran’s possession of nuclear weapons capability. This is viewed as a stab-in-the-back by the Saudis and the Israelis and will lead quickly to Saudi Arabia obtaining nuclear weapons from Pakistan.

Ron Paul added to this that the Saudis are furious at what they perceive to be the US not holding up its part of the petrodollar deal. He says:

The Saudis believe that as part of the US commitment to keep the region safe for the monarchy, the US should have attacked their regional rivals, Syria and Iran, by now. This would suggest that they may feel that they are no longer obliged to uphold their part of the deal, namely selling their oil only in US dollars. The Saudis have even gone so far as to suggest a “major shift” is underway in their relations with the US.

Several countries tend to strengthen each other in an attempt to evade the international petrodollar system.  Saudi Arabia, Israel, Egypt, and Russia are among those countries. Increasingly, they are setting up their deals in other currencies, including gold.

Signs to watch for

Confidence is the basis of the dollar based world reserve currency. Each sign of loss of confidence will be critical in the deterioration of the dollar’s leading role.

Going forward, according to Ron Paul, we should particularly watch for the relationship between the US and Saudi Arabia. The Saudis, with their unprecedented language towards the US, could become a turning point. As soon as we hear US officials talking about the “need” to transform the monarchy in Saudi Arabia into a “democracy” it could really mark the end game.

Other signs to watch for include a Gulf Cooperation Council central bank, a BRICS multilateral bank, the increasing use of the yuan, a regional ruble zone on the Russian periphery and the creation of a true Eurobond backed by the full faith and credit of all members of the European Monetary System. Rickards says that, while no one of these developments is decisive, each one of them represents an alternative to the dollar for a specified set of transactions. “Cumulatively these developments could push the dollar past a tipping point, where it collapses suddenly and unexpectedly after an initially slow decline.”

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