U.S. Reality Check: China, Russia Drop the Dollar

A look at how the use of bilateral trade settlement is growing

Chinese Premier Wen Jiabao and Russian President Vladamir Putin announced in St. Petersburg, Russia, on November 23, 2010, that they will stop using the U.S. dollar to settle bilateral trade and instead use the ruble or the yuan, according to a report in the state-run China Daily. Bilateral trade between the two countries stands at roughly $60 billion. Put in perspective, assuming two-thirds of international trade is transacted in U.S dollars, this accounts for 0.3% of dollar usage in a global economy valued at roughly $30 trillion. This agreement, then, is not particularly meaningful in terms of U.S.-dollar utilization, but when we consider the exponential implications, the effects are huge.

Consider the fact that China not only has this trade-settlement arrangement with Russia, but also has a growing list of settlement partners that so far includes Argentina, Brazil, Belarus, Iceland, Indonesia, Japan, Laos, Malaysia, Myanmar, Philippines, Singapore, South Korea, Thailand and Vietnam. And then, if each of these countries develops bilateral trade-settlement partnerships in their own currencies absent the dollar, how would this affect our currency, Fed policy and the U.S. economy?

To understand how this might play out, we need to take an imaginary trip to a border region of China and Russia: Let’s say there is a company called Sino-Russia Industries in China that supplies screws and bolts to a truck maker in Russia. On Tuesday, as this Russian truck maker holds USD$100,000 in its clearing account to cover the cost of the screws and bolts that Sino-Russia Industries supplies, news breaks that the dollar will no longer be used to settle trades. There is, then, no further need for the truck maker to convert rubles into dollars, and its dollars, for all intents and purposes, are worthless. So what does the truck maker do? The first act the company accountant would take is to ask the bank to sell the dollars for rubles. The bank may do so, but at a discounted rate. Those discounted dollars will be shuffled from place to place until they get to someone who knows where and how to spend those dollars for the best value: In America to buy in-demand consumer products for resale in his home country. We will call this person “Mr. Interman” – short for “Mr. International Businessman”.

As the shock waves rumble throughout the world that the two major powers of China and Russia are shunning the dollar, companies across the globe begin to hold only as many dollars as they must to get by – but no more – for fear that such a settlement deal may be struck between their nation and others in which they trade. Consequently, demand for Treasuries wanes as foreign central banks lower their U.S.-dollar reserves on falling demand for dollar settlement by their respective banking systems.

One way or another, Mr. Interman, a resourceful businessman, finds a way to get those cheap dollars into the U.S. With those funds, he buys plasma TVs, iPods, iPads, laptop computers and anything else of value that he can send back to his country. American retailers begin to notice that their inventory is moving off the shelves at a rapid pace, so they raise prices. But this is OK for Mr. Interman and those like him, because they are finding it quite easy to acquire hefty volumes of U.S. dollars from companies and individuals in exchange for just a limited amount of local currency. How do they do it? They simply put up a sign with a phone number on it that says, “We Buy U.S. Dollars.”

As prices creep higher, those on static salaries and fixed incomes suffer the most. Why? Dana Bryniarski summarized it best in her comment at USMoneyTalk.com, “The rich get richer, the poor get it free, and well, the middle class gets nothing.”

On price increases, Fed Chairman Ben Bernanke said, “...use of the term ‘quantitative easing’ to refer to the Federal Reserve’s policies is inappropriate” and prefers to use the term “securities purchases” as they “work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.” To that, I offer for following quote from William Shakespeare’s Romeo and Juliet: “A rose by any other name would smell as sweet,” for the dilutive effect of “SP2” on the dollar is no different.

I know the reason the Fed is buying hundreds of billions in Treasuries is to help prop up the housing market through “dollar rolls” and “coupon swaps” with Fannie, Freddie and various primary dealers; and I know those bond purchases also help the Treasury Department pay its mass of bills, but what Mr. Bernanke ought to do is go into meetings and hearings with pounds of smelling salts to help everyone snap out of their stupor. Listen: We are $14 trillion in debt; we spend $3.6 trillion a year on a $2 trillion stream of income; the Fed has shifted the printing press into hyper drive on plans to purchase $600 billion more in Treasuries, and we wonder why the international community is backing off, citing “risks in the dollar”? Knock, knock, knock. Is anybody home?

To the Federal Government: I suggest you immediately adopt “preemptive” austerity measures in order to save face. For you don’t want it to appear to the world that you were forced into budget cuts. So unless you choose programs and services to cut from the budget, it may be chosen for you by the bond market, because the foreign-finance window is closing fast.

To Investors: With the China/Russia announcement, it is evident the de-dollar process is underway. The die has been cast. Preserve your wealth and standard of living by buying gold (GLD, CEF), copper (JJC), oil (ERF, PGH), coal (NRP, PVR), iron ore (GNI), and fertilizer (TNH). China and India, each with over 1 billion citizens, are hungry for energy and economic growth. Much of the rest of the world is just plain hungry.

To Average U.S. Citizen: By God’s grace, most of us are well supplied with food, clothing and shelter. We have considered these basics in life. But in today’s world, it seems we must add two more items to the list: transportation and energy. I therefore suggest, if you haven’t already, that you consider settling down in an area you know you will/can live for a long time – a place conveniently located near your work and a shopping area; and to properly weatherize your home in order to save on energy costs. Also, invest in a deep freezer, and stock it with sale items. Bread and eggs can be frozen, as well.

In addition, the “Big Four” U.S. banks (Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo), which hold about 40% of all U.S. customer deposits, each have operations in more than 100 countries. Four points about them: 1) They are likely holding your cash; 2) thus, they are earning interest on your cash; 3) they are shielded from harm by your tax dollars; and 4) they make lots of money outside the U.S. Hence, as a fair exchange, they should offer every U.S. customer free checking and savings. If your Big Four bank doesn’t, find a bank that does.