PIMCO portfolio manager Curtis Mewbourne is getting a lot of attention for a new report predicting the long-term demise of the dollar, or at least its end as the undisputed reserve currency.
This kind of stuff is great for sensational headlines, though Mewbourne’s own argument isn’t particularly sensational or novel.
It basically comes down to: The emerging economies, notably China, are coming on fast, and China is starting to do more trade directly with other countries without the need for dollars.
China for example has entered currency swap arrangements with a number of countries so that trade financing can be negotiated in renminbi as opposed to dollar terms. In addition, several countries have signed up to replace part of their foreign currency reserves with new bonds issued by the IMF and denominated in SDRs (Special Drawing Rights), a basket of currencies.
Capital must flow somewhere, and recent data suggest that the patterns of the previous decades, when capital flowed out of emerging countries and back into core countries has to some degree reversed. Clearly the U.S. dollar benefitted from a strong flight to quality bid during the global banking crisis. However, recently we have witnessed a reversal of those flows, arguably at least in part due to concerns that the massive amounts of U.S. dollar liquidity produced in response to the crisis. Indeed, in emerging countries we are seeing some central banks intervening to limit appreciation of their currencies as capital flows back into their economies. These preliminary signs of a reversal in the traditional pattern of capital flows during a deleveraging cycle may well mark an important shift in currency preferences.
And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative. In combination with other factors, that likely means a continuing devaluing of the U.S. dollars versus other currencies, especially the EM currencies. Accordingly investors should consider whether it makes sense to take advantage of any periods of U.S. dollar strength to diversify their currency exposure.
Again, all this makes completely logical sense, but the leap to actually replacing the dollar still is huge. On a long-term basis, sure, it’s hard to imagine the dollar having a run in the 21st century anything like it had in the 20th.
Still, Mewbourne cites some eye-popping statistics, such as the growing size of the Chinese car market, and the amazing run in their stock market, which has grown bigger than Japan’s by market cap for the second time:
Mewbourne isn’t willing to call the Chinese market an unsustainable bubble, as so many have:
Some readers may perhaps fear that yet another asset bubble is forming, and that the growth in the Chinese market has come too far too fast, which of course is possible. At 25 times forward earnings and 3.8 times price-to-book, the Shanghai Stock Exchange Composite Index is far from cheap by traditional measures, and thus financial markets are likely reflecting more of a “voting machine” aspect of future expectations than a “weighing machine” measure of current value. But the fact is that we are witnessing real time indicators of significant changes in the global economy, with China clearly continuing its meteoric rise in terms of global economic importance. It is not surprising China’s market capitalisation is larger than Japan’s, given that the Chinese economy will probably surpass Japan to become the second largest economy in the world next year, measured in current exchange rates.
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