David Gracey

David Gracey

David Gracey

Head of Foreign Exchange and Fixed Income Trading

Episode 9.: The rise (and potential fall) of the USD as global reserve currency.

• Having taken this long cruise it’s time to draw some conclusions, but first a little perspective with absolute numbers.

• By now you are aware that the total US government debt is over 30 trillion USD …. As a percentage of GDP it's currently at 130%. 

• However what does the trend look like.

o In 1960 the debt to GDP ratio was around 53%

o In 2000 it was around 58%....all good. 

o However in the last 20 years it has doubled, but significantly it has grown from 108% to current levels in the LAST 3 YEARS.

• And that’s just the Governments portion – total US debt including households and business is more than 90 trillion USD.

• Here are select debt to GDP ratios from around the world.

o Japan – 250%

o Italy – 150%

o France – 113%

o China – estimated at around 70%

• All around the world National debt levels are rising fast.

• Multiple crisis responses have all enjoyed the same solution. Cut rates and raise debt coupled with QE.

• Debt has kept the world afloat, and it’s been relatively easy to do because, by and large servicing that debt has been comfortable because of low interest rates. Until 2021/2022.

• Now lenders are demanding higher premiums as inflation has returned to haunt the system.

• For the USA in particular (and more recently Europe) this has been easier because of the USD status as global reserve currency.

• Recall that all of the USD accumulated by exporting nations have to be warehoused. And that money is recycled and invested into the US treasury market.

• For example, between Japan and China they hold close to 3 trillion USD, invested into US treasuries.  Other nations reserves make up a significant part of the balance, followed by insurance houses, wealth managers and private money. All encouraged by the USA’s credit rating of AAA – the same agencies that rated those sour trifles as triple Michelin star cuisine.

• However the ground may finally shift. Slowly.

• In 2022 Russia invaded Ukraine and the global response was swift ….Russia was essentially shut out from the rest of the world and the Ruble halved in value very quickly.

• The problem is that much of Europe relies on Russia for its energy needs. Putin promptly demanded payment for gas and oil, not in USD, but in Rubles. Today the Ruble is roughly 25% stronger than it was before the invasion. It’s almost unimaginable that a nation that is at war and has seen its economy contract by roughly 10% this year, can celebrate a stronger currency. But it’s happened and its real.

• The Saudis and the Chinese are also exploring ways for China to pay for its oil imports in Yuan, again shutting out the USD as a payment mechanism.

• Other nations are trying to find alternate payment mechanisms for bilateral trade. 

• This means that over time the USD’s status as global reserve currency will be threatened. And this means that the US may find it increasingly difficult to fund its liabilities that are at record levels (And rising fast)

• History teaches us that  Sovereign hegemony cannot last forever. 

• From the Greeks to the Romans to the United Kingdom and many in-between. Systems change. Politics shift, and alliances are challenged, often as a result of economics.

• Imagine if you will what the impact will be if the Chinese announce that they are no longer investing in US treasuries. Or if the Japanese experiment of keeping rates low fails. 

• Imagine if some other mechanism for global trade finds traction.

• What does that mean for the USA’s ability to borrow at low interest rates. 

• Ernest Hemingway says in his 1926 novel – “Change happens slowly, then all at once”

• It could just be that we are beginning to see the beginning of the beginning.

• Drops anchor.