Reserves, China, Euro, Dollar, SDR, Gold, Oh My!

Gold has doubled in three years.  The euro has bobbed like a drunken sailor. Bailouts of institutions and countries abound.  And to paraphrase Winston Churchill “The dollar is the worst form of currency except all those other forms that have been tried from time to time.” Uncertainty reigns.

The global sovereign debt crisis and its fallout promoted me to gather some observations into what only the kindest could call it a scenario – albeit an incomplete, surely inaccurate, but hopefully interesting and useful -  of a new world currency order. While I suspect that this new world order will only be certain in hindsight, it will nonetheless have everyone looking for that someone who seemed to predict outcome. Way to go, hindsight bias.

My time horizon is more than three years and fewer than 25 years, the uncertainty driven primarily from my lack of deep knowledge of reserve holdings, global trade balances and how the international monetary system has changed and will change over time. While I do have a masters degree, I have no significant training in economics (I did stay at a Holiday…oh, forget it).

Where better to get myself a drubbing, share speculations, bounce ideas off a sounding board, and out and out ask questions than the Internet; the biggest “water cooler” in the world.

Clearly, the global economic system is insanely complex.  Scales of activity range across entity sizes from small companies, to small regions (regional banks, prefectures), to large regions (regional reserve banks, provinces, states), to countries, and finally to super-regional entities (ASEAN, OECD, European Union).  Multiple political and economic entities play various roles in shaping the global economic agenda including the IMF, World Bank, G-7/20 and the WTO.  My exploration will be confined to some select items I would like to see the financial press cover in a more thorough manner.

Please suggest corrections, post comments and ask questions in the comment section (do this by clicking on the number to the right of the very small voice bubble at the top of this post or clicking here) or email me at If you don't want to use the comment section, use this.  I will follow up in comments or subsequent entries.

Finally, I must mention that a significant inspiration to this exploration has been Dennis Gartman of The Gartman Letter (TGL).  TGL is an extraordinary publication, seemingly simple, with its daily revists to the same topics of Commodities, Energy, Equities, Politics Global, Capital Markets, and finally Recommendations.  But its simplicity belies Mr. Gartman’s depth of knowledge gained from 35 years in the markets.  He is a highly sensitive instrument, one that not only takes measurements of market moving indicators and events, but handicaps them in real time to hone in on the ones to which “attention must be paid”.  However, if this document simply results in the rantings of a madman, know that learning of TGL is the one sane thing you have taken away from your reading.

Reserves of Past and Present

There is a perception among some that reserve currencies naturally shift from one dominant currency to another.  This is both true and untrue.  While a majority currency is common for long periods of time, less common are periods of time during which a reserve currency strays to far above a the super-duper-majority of 70 percent majority of global reserves [1]

“Transition to” Versus “Transitional”

Discussions regarding the dominance of global currencies are increasingly common, the aftermath of the Great Recession only increasing their frequency. These discussions often focus on what the next new reserve currency will be.

Times sure change in these discussions.  Five years ago (or so), there was excited surrounding a plan to denominate oil in euros.  With the European Union and its euro under threat of extinction, the conversation has shifted to other possibilities; everything from a “basket reserve”[2] consisting of various commodities and/or currencies, to just gold itself, to the yuan if only capital controls were lifted.

A commonality in all this is that countries want move away from the U.S. dollar. Questions to ask about this might include: to what other reserve(s), when would it start, how long would it take to take place, how extensive would be the shift, who would take part in this transition and why is it such a hot issue?

  • Has it started? Yes, but not TO gold. See below.
  • What other reserve? The dollar is dead, long live the dollar. See below.
  • How long will the transition take? Depending on the economic condition of the United States (condition not just as articulated by the bloviators) relative to its real relative place in global economy, from three to twenty five years.
  • How extensive will the shift be? Let’s entertain a 60 percent to a 30 percent drop in the dollar’s share of global reserves. Some will argue, with some merit, that there is potential for a drop to five percent or less.  I am more hopeful than that, and believe there are reasons this won’t happen.
  • Who would take part? All global sovereigns would jump on the bandwagon to some extent or another.
  • Why such a hot issue? Because of the story it tells about global dominance.

Due to China’s outsized reserve holdings, its outsized holding of United States debt in their existing reserves and its outsized role in the global economy, attention will significantly be paid to China and the U.S. dollar as reserve currency.

Dollar, Shmaller

The dominant reserve currency is usually the currency of the global hegemon of the period.  The hegemon will have the best combination of economic and military might for the era.  Thus the argument can be made that the yuan [3] shall rise. However, predictions of its imminent and rapid rise and the dollar’s concomitant fall would be incautious.

The dollar is going to retain a role in global reserves for a few more decades for a very simple reason.  It is the only globally dominant currency capable of serving in its current role.  There is NO sufficiently strong replacement. Everything important and the vast majority of traded goods are denominated in dollars and transacted in dollars. Even if a new reserve is nominated and adopted, it would take years of diversification, dollar draw down and revaluation to make significant headway. China knows that an orderly retreat (aka slow) is in its interest with its two and a half trillion dollars in reserves.  Yes, with a “t” trillion.  More on that latter, too.

What about a basket currency? A basket currency wouldn’t require one strong global government, just an effective economic framework [4] .  Guess who would have a seat at the table?  Guess which currency would make up a significant share of the basket, at least early in the basket’s life? Even after China surpasses the United States in GDP terms, what currency will have reserve inertia? In spite of many salivating at the chance to replace the dollar with something else, the dollar shall remain dominant for decades. [5]

Why isn’t China opposed to a basket more publicly?  Stepping back, why is China so obsessed at maintaining an export economy by pegging the yuan to the dollar thus keeping it artificially low?  Here is my woefully simplified explanation; China has decided that it isn’t time yet. While China’s middle class is developing nicely, the communist apparatus is terrified that a severe economic downturn will cause revolutionary upheaval, upheaval that may threaten the existing hierarchy. [6]

China then, partly through its enormous might, has taken on the task of supporting global economies and currencies, including the euro and dollar.

As for the basket, I suspect China believes that the basket’s formation is in the distant enough future that it doesn’t threaten its long term plan while diverting attention now from the too cheap yuan.  Longer term, however, it is possible that China is fairly sure that it will control a significant share of global commodity reserves and thus give it a modicum of control over a global basket currency which could include one or more commodities. Finally, China would be determined to have the yuan included in the basket over time as it relaxed currency controls enough to convince the economic entity in charge of creating and managing the basket that it was a good global player.

Gold for All, or Folderol?

What about gold, you ask?  A little quick math.  Global foreign exchange reserves or international reserves are currently around 10 trillion dollars [7] . An estimate of ALL gold ever mined is 165,000 tonnes. [8] With a notional value of $1,200 an ounce, that amount of gold totals approximately seven trillion dollars.  Not only is this three trillion dollars short of existing reserves, but much of that gold is lost or highly unavailable in oceans, burial grounds, sewers, unrecoverable industrial use and strongly held private property.

Thus, even if gold were seriously (re)considered [9] as a new reserve currency, it would take years of mining, extraction and significant price increases in gold’s value.  Fifteen hundred dollars an ounce is currently within spittle distance, but $15,000 might be a more realistic price for gold if it was adopted as a significant reserve.

Of course, as a transitional currency, gold may be quite interesting. In fact, my entirely uneducated, five to ten year late guess is that the rise in gold is in part due to the use of gold as a transition away from the dollar — and now away from the euro, too.

Just think, something which has been a reserve of value for millennia would be a useful stepping stone out of an undesirable currency.

The process will be slow and methodical. Players of any size, notably China and other BRICs will have every interest to prevent the price from rising too fast before they have had the chance to add serious diversity to their new, shifting or enlarging reserves.

During the build up, no one important shall utter anything related to “gold doesn’t do anything or generate dividends”.  And really, after at least five millennia, who is to argue with the persistent value of gold? [11]

Higher variability in price swings might accompany some portion of the accumulation and later distribution cycle because governments would only be using it as a temporary measure. Or not (if governments are managing the price via self-control and coordination.

Thus the endgame could just as interesting and unknowable as the journey.  Once their journey to the new currency order is complete, gold holders will then shift to buying the new real global reserve currency(s), while keeping their gold as a diversification strategy. Maybe they sell gold slowly over time.  Maybe it will be sold quickly.  Maybe they will trade in and out of gold as market manipulators (happy, gold conspiracy theorists?)

But this scenario suggests that this same strategy can be employed with other precious metals, semi-precious metals, gems, and soft and hard commodities alike.  Why wouldn’t we find dozens of emerging market sovereigns hoping across the pond between the dollar and the new world currency order, on stepping stones of a dozen or so varieties? We would, we do and we will.

Clearly, gold has (once again) become a reservable asset and is currently being used as such by most global sovereigns.  But to what extent and for how long remains an important question.

With Great Reserves Comes…

China’s existing foreign reserves for now are a caged lion.  An estimated 70 plus percent of them are in US dollar-denominated assets, with Treasury securities and GSE debt, preventing easy or fast wholesale liquidation without inflicting damage to itself and global markets. [12]

But hundreds of billions of new reserves are generated annually, largely based on the current account surplus, allowing, and to some extent requiring, those new reserves to be put to use in powerful ways.

Being the strange hybrid economy that it is part market-based and part command and control, means strange things result from this arrangement.

Internally, because of its trade imbalance, China constantly needs to sterilize its liquidity to prevent runaway inflation.  Raising reserve requirements on banks is one of their favorites [13]

These inflows can be used to build things, even unnecessary infrastructure – unfrastructure?

Outside of China, though, this is where the next 25 years and beyond will bring news of things to which people will REALLY react.

Back in the late 1980’s, there were fears was that Japan would dominate the world economy.  Microchips, electronics, manufacturing would all be ruled by Japanese design, and manufactured in Asia.  In hindsight, it is somewhat quaint to remember, but people were truly freaked out at the time that foreigners would own Rockefeller Center in New York City, a quintessential American landmark.

Ultimately, the Rockefeller deal fell apart and Japan immolated.  China is more populous and productive, will grow bigger, and express its power more widely than Japan ever did.

Chinese can fight wars, directly or through proxies. It recently purchased an unfinished Russian carrier and is building two more.

The Chinese can buy off countries.  Ok, more precisely, it can exert influence of all kinds with the amount of money it generates.  Their support of Costa Rican bonds for perhaps diplomatic recognition or trade consideration is certainly only one of many examples. [14]

End Game

It is said that every end is also a beginning.  The end of U.S. dominance as THE global power is upon us.  And no, it is not this president’s, or ANY president’s fault. Countries and their historical arcs are the result of the aggregate of nearly incalculable numbers of individual decisions, interacting with their environments which include resources, cultures and countries, hundreds of politicians, even our own genetic tendencies.  Anyone’s argument that Obama is helping the downfall of America by spending on stimulus and corporate bailouts is as silly as mine that Reagan hypocritically grew the deficit even as he fought government largess while not trying harder to instill in us a culture of hard work and sacrifice in anticipation of the global flattening that is occurring daily.

Meanwhile, I will watch in fascination as the day approaches that China gets serious about revaluing the Renminbi

Let’s imagine the year 2020 for the moment.  What do China’s reserves look like? If China generates about $400 billion a year in current account dollars, that could be an additional four trillion dollars by 2020.  However, let’s build in at least one slowdown and make that on average $250 billion a year.  For ten years, that gets China an additional $2.5 trillion.

In that time, some sort of basket currency will be in at least limited use, and China will be taking advantage of it.  Thus in 2020, China will have:

  • 2.5 Trillion Dollars American (50% of reserves) – worth who knows what in 2020
  • 1.25 Trillion Dollars in Yuan (25% of reserves)
  • 1.25 Trillion Dollars in basket currency (25% of reserves)

Does the yuan appreciate after being unpegged from the dollar?  If it doubles in value, does that mean that the yuan share of reserves is also doubled?  If the basket contains appreciating commodities or other currencies, like the Brazilian real, might the basket also have more purchasing power than the already huge number indicates?

By the way, the speed bump is being predicted by those who see the Chinese real estate bubble as simply one cockroach of many.  And with a bus as large as China, well, driving over a bump results in one heck of a wallop.

In spite of a speed bump, if China navigates effectively, its monetary actions may be one of the greatest investments ever made.

Emerging Markets Enter Stage Right, Developed Countries Exist Stage Left


China power conspiracy theorists have not done a good job of laying out coherent arguments which integrate the motivations of all the significant actors.  Large scale currency and reserve movements are part of a much larger story of the passing of an old hegemon.

Oh, just image the conspiracies.  Instead of some million pointed global liquidity, think of a single huge liquid pool of money, ready to be called on by the communist Chinese cabal to do many “big things”. I can hear Dr. Seuss now, “…the things one could do with 2.5 trillion dollars, and double again what one could do with 5 trillion.” Really, conspiracies need not even apply; after all, many of the things global hegemons do, they do in the open.

Certainly, China has real internal needs for a rainy day fund.  What if central planning fails?  Scratch that; when central planning fails in one or more key areas, that money will help them buy their way out of the hole.

And China has needs that the United States of America didn’t for years into its youth – resources.  With only 6% or so of the land being arable, China needs to import food, lots of it [15].  This need compounds greatly with its burgeoning middle class’s desire for meat as opposed to vegetable nutrition.

It is said that command and control economies are ultimately doomed to failure.  Man can never be as smart as the invisible hand of enlightened self interest. Who the winner would be in a Cold War between the free United States and the oppressing Soviet Union in hindsight was a no-brainer, as long as we never stepped across the line of no return.

China is not in this boat, nor even in the same ocean.   China is a vastly wealthier nation resulting from its hybrid capitalist-socialist model.  It is not competing to build a vast, land based, hardware laden military complex to counter a clear and present enemy [16]. It is less tied to a rigid ideology, makes course corrections and is better at public relations.

This is not to say that China won’t stumble; it is becoming clear that unless there is some truly brilliant plan to fill the increasing numbers of empty skyscrapers, it will experience a crash in the next few years.  Just as surprising, however; may be China’s recovery from this debacle, partly aided by the rest of the world which has seemingly chained every one of its boxcars to the China locomotive. But its multi-trillion dollar buffer will likely buy it softer landings and faster take offs than even the most rosy commentators predict.

One last item which needs to be stated carefully, for it is not intended to offend.  We have been relatively free of large scale wars for over half a century.  Over fifty million people were killed in World War II, with over 400,000 Americans.  “Only” two million [17] were killed in Vietnam with around 58k U.S. soldiers killed.  Iraq War estimates are around 120,000 [18] with under 5,000 American deaths.  Fatalities in each of these wars have dropped by an order of magnitude.  Although certainly not to each individual soldier’s and civilian’s families, recent wars have been relatively less cruel in terms of loss of human life, particularly in the industrialized world. This may not continue to be the case.

If Herman Daley, Garrett Hardin and their academic descendants are right and our environment being a truly limiting factor in the production of food and other goods, we may find ourselves battling on a global basis for resources.  Wars may not be of world war scale, but we should not expect these new wars to appear as our most recent wars.  There may be more of these wars, with the use of unpleasant new technologies, where we find ourselves without the upper hand as we so often had in the past. [19]

If we are lucky, persistent struggle of this kind might just mean that the standard of living for developed countries will continue to drop while the cost of living rises, with the opposite being true for developing countries [20] . The sides may decide that the cost of war would be too great. I hope for the best, while planning preparing for the worst.

[1] A supermajority is ANYTHING over a simple majority; 51 percent is a supermajority if that is required in a set of bylaws or a constitution. Super-Duper-Majority, well, that must be 70 percent or more because I say so. While on the topic of reserves, if anyone has a good source of top foreign reserves holdings going back 300 years or so, that would be a great data set. I would love to see a stacked line chart showing the dominant currencies, including silver and gold reserves that were held as tumbagas, reales, escudos, etc.

[2] I use this as a general term for something like an expanded Special Drawing Rights (SDR), but whose organizer and composition is uncertain.

[3] Abbreviations and acronyms for the yuan currency include Chinese Yuan Renminbi, CNY (official currency trading abbreviation), redback (because of the color of the 100 yuan bill, complete with picture of Mao) RenRen (I made this up to equate valuable currencies with large social networks), CNY (Yuan currency code on Forex), Renimb (misspelling). The Yuan is a decimal system, with the fen being the equal of the U.S. cent, a Jiao the equivalent of the U.S. dime and Yuan equivalent to the dollar. Nicknames include kuai and mao (with accents often over the a in both cases – so the Internets tells me). And remember, Yuan is to Renminbi as Dollar is to US Legal Tender.

[4] The Euro zone experiment has lasted ten years, not bad considering there are no fiscal controls at the “local” country level

[5] …there I go again, precluding the possibility of a black swan….

[6] There are half a dozen real explanations, and it is hard for me summarize them; what if the Chinese refuse to begin to consume internally?  Germany, and maybe the world morso, keeps waiting for Germany’s people to consume more. What if the revaluation really spurs Americans to produce more? (ed. note: fat chance)



[9] Gold was mined in colonies and turned into gold coinage for reserve and trade; these coins variously included Sovereigns, Sol, Escudos and Ducats

[11] Over the years, I have heard two numbers of loaves ascribed to the value of an ounce of gold, one with purported biblical roots; 200 and 350.  I will attempt to find you kind readers the exact biblical line in which the number is specified.  Also, arguments have been made that gold ought be valued at a price closer to that which it costs to pull it out of the ground, which is currently around $450 bucks. And yet here we are.

[12] Contains widely speculated 70 plus percent number, plus an interesting and thorough article to boot

[13] Thank you Gartman Letter again for updates on what China is doing.  And by the way, RE-discount rate?  Who knew?


[15] While this wikipedia article suggests that 15% of China’s land is “cultivatable”, a number I heard used in a number of interactions with Chinese officials and have read elsewhere is that a realistic number is closer the 6% that I have cited.  This is due to urbanization, land access and transportation issues, etc.

[16] Yet.

[17] The wiki entry was remarkably unclear as to a consensus number like many of the other war entries. It could be as low as one million or as high as five million.

[18] Again, wiki entry quite complicated, but even at the high end the number doesn’t top one million.

[19] I have always debated; should a futurist read the writings of other futurists?  Or should the vision of a futurist be pure and unadulterated with the predictions of others? Certainly one pitfall of the unadulterated method is that George Friedman or other predictor has already written about the issue ten times more articulately, with higher accuracy.

[20] I was going to say something like; “The cost of animal protein will rise to prohibitive levels for the average worker” but I have learned from the Simon / Ehrlich Wager – it’s about systems failures, not specifics shortages.

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