The US dollar has been the strongest of the major currencies in the past few years. This has surprised many investors, who expected the dollar to crash as a result of high levels of money printing during the pandemic.
To be sure, the USD did initially drop sharply as stimulus packages were announced during the pandemic. Massive amounts of new dollars were created in stimulus packages designed to avert an economic collapse. In fact, nearly 20% of all dollars ever created came into existence during the year 2020! The Fed’s broadest measure of the money supply, called M2, increased from $15.5 trillion in February 2020 to $21.7 trillion two years later. That is an increase of roughly 40% in just over two years!
But the creation of new dollar has also come to a halt. After topping out in March at $21.7T, the M2 money supply has flat-lined and started to decline a bit to $21.5T today.
After the initial dollar weakness, the USD Index has since rallied from 89 in June 2021 to a high of 114 last month. This 28% move in just over a year is very significant for the dollar index.
It came primarily as a result of the Federal Reserve raising interest rates aggressively, out pacing the moves of other central banks. And while the Fed was raising rates aggressively, Russia, China, Turkey and a handful of nations in South America, and Africa have actually cut rates.
So the U.S. dollar has been able to rally and remain strong as a result of rapidly rising interest rates and and turning off the Fed’s printing press. The stronger USD has been acting as a safe haven while stocks have tanked in the past year. The key reason for rapidly raising interest rates in the United States is to combat record levels of inflation and keep rising prices from spiraling out of control.
And it must be noted that the USD Index measures the dollar against a basket of other fiat currencies, most of which are also printing into oblivion and devaluing. This accentuates dollar strength.
Could a Gold-Backed Currency Replace the Dollar?
But what would happen if the dollar had to compete against a leading currency that was not unlimited fiat money and was actually backed by more than thin air? In this case, the money would be backed by one of the scarcest assets in the world, gold.
This week the media is reporting that China and Russia may be working toward a new gold-backed currency in a move that would aim to dethrone the dollar as the primary reserve currency of the world. China earlier this year started to buy up huge quantities of gold at the same time that Russia was forced off the dollar due to sanctions in response to the invasion of Ukraine.
“Some experts caution that these moves, along with the closer relationship that has developed between Moscow and Beijing as the rest of the world has isolated Russia after the invasion, point to the likelihood of China attempting to launch a new currency with gold backing it. In essence, Beijing and Moscow are seeking to build their own sphere of influence and a unit of currency within that sphere, in effect inoculating themselves from the threat of U.S. sanctions.”
Swiss gold exports to China hit a five-year high, with Beijing in July alone receiving 80.1 tons of gold valued at around $4.6 billion – more than double the 32.5 tons it bought in June and the second-highest monthly total since 2012, according to Reuters.
We note that similar rumors have gone around in the past, but both nations have been building gold reserves and are increasingly cooperating on economic issues. With the US engaging in a proxy war with Russia and utilizing financial sanctions, this has accelerated the odds and the timeline of such a gold-backed currency coming from China and Russia.
This latest news is also coming just a month after Moscow has proposed its own international standard of precious metals exchange , dubbed the “Moscow World Standard” (MWS).
Using gold to back the currency would be the best way to build global confidence in a new currency and compete with the dollar. It would accelerate the current trend of de-dollarization and give nations globally another option for settling international trade. It is estimates that around 43 % of global trade is done in dollars, down from 60% a decade ago.
Saudi Arabia is more closely aligning with Russia and China, looking to accept the yuan as payment for oil, which threatens the petro dollar. Simply put, the rein of the dollar as global reserve currency is likely coming to an end. If Russia and China collaborate on a new gold-backed currency, it is likely to further accelerate this process as people start using more sound money.
If this happens, we are likely to see a major upward revision to the gold price and this will greatly benefit the stocks we hold in the GSB portfolio. So we continue to advocate holding a mixture of physical gold, silver, and shares in the top companies that mine these metals. During the early stages of bull runs, top-tier mining stocks typically offer leverage of 3x to 5x the move in gold. So if the gold price were to double from $1,650 to $3,300 over the next few years, we could expect some of the companies in our portfolio to go up 300% to 500% in the same time period.
But there are a few major concerns regarding the China/Russia gold-backed currency. First off, it is expected to be digital and allow governments and central banks dangerous levels of control to monitor and freeze accounts much as they would with current CBDC iterations. A person’s funds could be locked up for protesting against a government or sharing information on social media that the government does not like. This would be a dark development toward unchecked government power like Orwell warned about.
And the second major concern is regarding counter-party risk. While we view commodity-backed currencies as vastly superior to unbacked fiat currencies, they still require trust in the counter-party as custodian of the gold. Will they abuse this trust by moving to fractional reserves or not allowing convertibility from paper to physical gold if demanded? Could the gold backing the currency be confiscated in times of emergency?
Is Bitcoin Better Money?
For these reasons, many believe that Bitcoin is a better alternative form of money to the dollar or even a gold-backed currency. It is decentralized, so there would be no potential for abuse of power or censorship. It does not require third-party custodians and does not involve counter-party risk. It is strictly limited in supply, so there would be no concerns about fractional backing.
Many will scoff at the idea of Bitcoin becoming an international currency used for trade and held on the balance sheets of banks and major corporations. But this is already starting to happen and while volatile at times, Bitcoin has proven its value. We have seen increased adoption from both retail and institutional investors, nations making it legal tender, U.S. states and cities accepting it for taxes, politicians accepting it for donations, and major retailers accepting it for payment. The network as never been hacked and is more secure than ever with the hash rate recently hitting record levels.
While it is tempting to pick one over the other and then dig in to defend a particular position, we believe the proper course of action is to hold both gold and bitcoin. In NIcoya Research portfolio, we recommend this approach and include our top picks for both mining stocks and cryptocurrencies. 2022 has been a rough year and won’t attempt to sugar-coat this fact. But we believe that gold and bitcoin are likely at or near a bottom for this cycle and that generational wealth can be built by buying when others are panic selling.
The Federal Reserve is likely to reduce the pace of rate hikes and end them completely over the next 6 months. Investors need not wait for the actual pivot, as asset valuations bottom and start trending higher on the anticipation of the pivot, not the actual event. There is always the risk of catching a falling knife, but we believe it makes sense to start increasing exposure or building new positions at this time. If you would like to follow our trades, you can sign up here: https://nicoyaresearch.com/premium-services/.