By Keith Fitz-Gerald
You can't help but feel a sense of deja vu.
At least I can't.
The last time the dollar fell this low and energy was this costly, traders were concerned about a massive recession, we were talking about a scary new economic syndrome called "stagflation," and the Major League Baseball's Pittsburgh Pirates and Baltimore Orioles were actually perennial contenders.
It was the 1970s. The economy – then as now – was slowing as investors realized that Washington's tough-talk and economic policies were nothing more than smoke and mirrors.
But the world has changed in the three decades that have followed. What's different now is that we have a situation where our three largest creditors – Japan, South Korea and China – also are our largest trading partners.
And one of those trading partners – China – is extremely displeased by the weakening dollar.
In fact, all three partners are so upset that they've been making some very public noises about diversifying away from the greenback, or – and this is a huge deal – even dumping some of the $1.3 trillion worth of dollar-denominated debt instruments they hold.
China's Greenback Angst
The gloom-and-doom crowd has labeled this scenario as China's "nuclear option," because having China dump dollars on a wholesale basis would be akin to China lighting off a hydrogen bomb in the worldwide financial markets.
Come to think of it, I recall reading something in China's press that employed the same slang term, so it's not clear just who used it, first.
Anyway, from the way the media has reported this to date, you'd think the world was about to end.
Well, I don't think so and when you get down to it, I really don't think China's "atomic saber-rattling" is much of an actual threat. In fact, I think it's pretty benign.
For one thing, what China is supposedly saying is really nothing new, despite how the press is treating that country's recent commentary on this issue. The truth is, China has been making noises about this for years, and so much of what's being reported right now is really just ‘standard operating procedure,' or S.O.P., for both U.S. and Chinese diplomats whenever they get together.
The manner in which the remarks were made is also a business-as-usual because the Chinese often use academic types to make what are essentially pending policy level announcements. That way, the official apparatchiks can remain unscathed should there be some unforeseen global backlash, which prompts a retreat or a potential loss of face.
Why There's Bluster, Not Blasting, to Come
How this ultimately all plays out remains to be seen, and is really impossible to predict (though I doubt it will be as bad as some fear). But even if nothing comes of this, there are some things that need to be understood:
First, there is literally not another currency on the planet capable of absorbing a few hundred billion dollars. Therefore, even if China actually decides to dump the dollar, there literally isn't any other currency that could stand in and absorb the excess capacity if China were to go shopping for alternatives to the greenback.
The European euro is at record levels and EU governments are struggling with how uncomfortably high it's become. The Japanese yen, which would have been a good candidate in the past, has effectively been neutered by what's left of the carry trade. Other countries are either unstable, or too small, for to be relied upon. The Middle East, Russia and Africa are hardly the poster children for stability, so they're out too. As for the rest of the Asian Rim, those countries are too small to have meaningful places in the fiat currency arrangements relied upon by world bankers as a source of checks and balances which is why they're not included in any of the major currency trading "pairs" in the FX markets at the present time. The bottom line: If China were to start dumping dollars, it would simultaneously put at risk every other currency it its basket in the process. It knows this. Therefore, by making such seemingly vitriolic pronouncements, what China is actually doing is to cement in place its own version of Mutually Assured Destruction – which helped keep the United States and Soviet Union out of a nuclear throw-down during the Cold War.
In doing so, China is attempting to create enough fear to make sure the world will never want to square off against it. And the Democrats who look increasingly likely to inhabit the White House next year will be fearful of enacting the punitive tariffs they're talking so toughly about right now.
At the end of the day, China knows just how dependent they are on exports, so dumping dollars is hardly conducive to continuing those relationships, particularly since the last time I checked more than 50% of Chinese exports were headed straight for the U.S. market.
To be clear here, though, there is an element of truth to what the gloom-and-doom crowd alleges. China will continue to posture and undoubtedly will engage in short-term allocation changes designed to make clear its point. But, beyond that, nobody in Beijing is going to push the financial nuclear "button" as long as we're all mutually engaged.
Over the long term, however, if we can no longer claim mutual engagement, then, frankly speaking, we'll have bigger fish to fry. And currency dumping won't even be on the radar screen.
Second, for all of China's noise about how low the United States is letting the dollar sink, China has to share some of the blame. For that reason, I'd even go so far as to suggest that China's threats are really a call for help.
For all its growth and prowess as an emerging world power, China's financial markets remain remarkably primitive by world standards. What's more, their capital markets remain woefully underdeveloped for the economic structure that's being developed. As a result, the Chinese are actually uniquely dependent on a falling dollar to succeed over the long term.
And that brings me to my third point, which is that China is really an overvalued economy masquerading as a highly developed one. Like others before it, China will realign its interests and, at a time when the market chooses, the value associated with it will revert to longstanding norms.
What's more, despite the fact that neither party will admit it, both the United States and China will emerge as stronger beings for having danced this financial Lambada together.
Deja vu All Over Again
Are you skeptical of my scenario?
If you are, I can't blame you.
But, as Yankee great Yogi Berra used to say, "it's Deja vu all over again." In other words, we've seen and heard this whole "currency dumping" hypothesis at least once before. If you think about it for a minute, you'll know just what I mean.
What's going on now is really just a replay of the 1980s, when Japan was viewed as an unstoppable juggernaut, and the Yen as the currency that would soon dominate the worldwide economy. People have apparently forgotten that Japanese businessmen were regarded as modern day samurai. Words like ruthless, cunning, and predatory were bandied about.
They've also forgotten that many the charges presently being levied against the Chinese now were levied against the Japanese then.
I think you know where this is going, but let me close the loop anyway.
Long story short, the Japanese waded into financial markets around the world, snatching up prime assets in nearly every country at fire-sale prices. There was a huge, emotionally driven backlash at the time when such assets as the Pebble Beach golf course and Rockefeller Center office building went up on the auction block and were snapped up by Japanese suitors. Later in the game – toward the end of Japanese hegemony – they were actually paying irresponsibly high premium prices for the assets, but that's another story.
What's vitally important to remember is that the Japanese Yen, as powerful as it was at the time, actually played an important role in setting the foundation for one of the longest, most profitable bull runs in history as the excess value they brought to the market was absorbed by other economies, including our own.
Will the same thing happen this time?
I don't know for sure. But having participated in the great Japanese buying binge firsthand, I'm betting that if you follow the money, as Money Morning advocates, you'll profit this time around, too.
You'll also get a potential two-for-one deal at the same time that's likely to result in higher returns, too. The reason is that by purchasing Chinese firms on the prowl as well as their intended targets in the natural-resources, financial-services and hi-tech sectors, you not only set up your investments for some healthy appreciation, but you also hedge your investment dollars from further decline by owning shares denominated in other currencies.
About the Author
Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.