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A Changing Dollar Value Impacts Investment Returns and US Inflation

 

In his upcoming book, “Bonfire of the Sanities,” author and investment advisor David Wright warns that “actions have consequences” and that the move toward electric vehicles and the progression to eliminate reliance on fossil fuels could weaken the US dollar. In recent weeks his warnings are heightened by reports that China has been in discussions with Saudi Arabia to price barrels of oil in something other than dollars, in this case, the Chinese Yuan. If successful, how would US dollar-denominated investments fare?

Background

When the US took its currency off the gold
standard in the 1970s, it negotiated to tie greenbacks to energy in that most oil around the globe is bought and sold in US dollars. This, in effect, made dollars backed by oil, (petrodollars) and added constant demand for greenbacks which helped its strength relative to other currencies.

When the US imposed sanctions on Russian foreign currency holdings, the power and risks of relying on the US currency did not go unnoticed by other nations. China as reported recently took steps to have oil denominated in its own currency, the Yuan, which would likely add to higher demand for the Yuan while reducing demand for dollars. If China’s Yuan is “upgraded” in the world, it could in effect be seen as a downgrade to the US dollar.  It could also cause a devaluation that translates into more inflationary
pressures and a reduced desire to own US assets, including stocks. Imports, especially from China could cost more.

Further impacting the dollar’s dominance, in recent weeks, Russia and India entered talks to enact a Ruble/Rupee exchange ledger for transactions. Moscow has also said Europe would have to use Rubles to pay for its natural gas and that it may consider Bitcoin as well.  Fewer global transactions are taking place in dollars.

 

Potential Impact

Baizhu Chen a professor in the Clinical Finance and Business Economics department at the University of Southern California is quoted in Business Insider as saying, “The use of Chinese currency will inevitably expand and play a much bigger role in the world.” Chen explained, “Some countries feel their economies could be held hostage to US policies because the dollar is dominant, and countries want to diversify their risk.” So, while reduced demand for oil could play a role in valuation, current policies that use dollar-denominated finances have caused eyes to open to the risks of not diversifying currency use in financial dealings.

The Yuan has been gaining popularity. Approximately 70 central banks hold some yuan as a reserve currency, while many African and Middle Eastern nations have adopted it for transactions. Central banks, according to the International Monetary Fund (IMF), have been diversifying their holdings, and reducing the dollar’s share of global reserves.

“Were the dollar to lose its status as the world’s reserve currency, it would raise interest rates for our historically large debt relative to the economy,” warned Tomas Philipson, former Acting Chairman for the White House Council of Economic Advisers. This of course causes concern as it would mean US consumers and businesses would face higher borrowing costs along with higher import prices.  

 

Current Status

For now, greenbacks comprise 60% of global reserves versus the yuan’s 2.5%. In global payments, the dollar accounts for 40% while the yuan has about 3%, even though China is the second-largest economy, trailing closely behind the US, Philipson said. That could change, but it would take massive reforms.

 

A More Competitive Yuan

China would have to open up its market and relax controls, according to Baizhu Chen. He noted that historically, no currency that has had heavy-handed control has become one of the dominant global reserve currencies.  China would also need to refrain from currency manipulation. This takes place now in the form of devaluing the yuan to boost exports, according to Chen. This could be facilitated by allowing for an independent central bank with transparent decision-making.

In addition, the yuan must become as stable, reliable, and trustworthy as the dollar. “Countries generally trust that the US isn’t going to screw up. But whether the yuan could be perceived as a store of value — a safe haven during uncertainty or war — that is a much more difficult thing,” Chen said.

The current trend in China has been more control, not less. There have been signs that the government will ease up on its recent tech sector crackdown – the market (Chinese stocks) reacted positively. It’s uncertain whether this will lead toward more easing of control.

Paul Hoffman

Managing Editor, Channelchek

 

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The Case for More US Produced Uranium

 

Sources

https://www.imf.org/en/Publications/WEO/Issues/2022/01/25/world-economic-outlook-update-january-2022

https://www.imf.org/en/publications/weo

https://wrightfinancialgroup.com/resources/newsletter

https://markets.businessinsider.com/news/currencies/dollar-vs-yuan-china-currency-global-reserves-central-banks-russia-2022-3?utm_medium=ingest&utm_source=markets

 

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Soaring Crude Prices Make the Cost of Pretty Much Everything Else Go Up Too – Because We Almost Literally Eat Oil

 

The price of oil has been spiking in recent weeks in response to concerns that the war in Ukraine will significantly reduce supply. But what happens in oil markets never stays in oil markets.

The price of U.S. crude oil jumped to a 13-year high of US$130 of on March 6, 2022. It has come down but has been trading above $110 since March 17. That’s over 60% higher than it was in mid-December, before fears of a Russian invasion began to mount.

Of course, this has pushed up the cost of gasoline, which hit an average of $4.32 per gallon in the U.S. on March 14. But it’s less well understood how rising energy prices leak into the prices consumers pay for toys, electronics, food and almost every other product you could think of.

Energy is becoming one of the main causes of inflation, by which I mean a sustained, generalized increase in the prices of goods and services in an economy. The latest data shows prices are rising at an annualized pace of 7.9%, the highest in 40 years.

 

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It was written by and represents the research-based opinions of Veronika Dolar, Assistant Professor of Economics, SUNY Old Westbury.

 

In my economics classes, I like to joke to my students that we eat petroleum. Students have a hard time imagining drinking crude oil or gasoline, but in fact it’s both figuratively and almost literally true – and I’m not even referring to how humans ingest about a credit card’s worth of oil-based plastic every week.

Let me explain:

 

 

Planes, Packages and Polyester

Oil prices affect the prices of other goods and services in a few significant ways.

The most obvious is that petroleum powers the vast majority of cars, planes and other vehicles that move stuff around. About 71% of the 6.6 billion barrels of petroleum the U.S. consumed in 2020 was used for various types of fuels, such as gas, diesel and jet fuel.

This pushes up transportation costs and makes shipping everything from refrigerator components to everyday items like toothpaste more expensive. Businesses can choose to absorb the cost – for example, if their market is highly competitive – but usually pass it on to customers.

But oil is also a key ingredient in much of the stuff people buy, both in the packaging and in the products themselves, especially food. That’s where most of the other 29% of the oil Americans use comes in.

Petrochemicals derived from petroleum are used to manufacture clothes, computers and more. For example, the quantity of oil-based polyester in clothing has doubled since 2000. Over half of all fibers produced around the world are now made from petroleum, requiring over 1% of all oil consumed.

In addition, the cosmetic industry is heavily dependent on petroleum since items such as hand cream, shampoo and most makeup are made out of petrochemicals. And like with many products, all those creams and beauty liquids are put in single-use plastic containers made from oil.

Similarly, the vast majority of toys produced today are made out of plastic.

 

Crude In Our Cookies

The food industry is especially sensitive to the price of energy, more so than any other sector because petroleum is such a key component of its supply chain at every step of the way, from planting and harvesting through processing and packaging.

Interestingly, the biggest usage of petroleum in industrial farming is not transportation or fueling machinery but rather the use of fertilizers. Vast amounts of oil and natural gas go into fertilizers and pesticides that are used to produce and protect grains, vegetables and fruits.

That’s one of the reasons it takes 283 gallons of oil to raise one 1,250-pound steer. And it’s why even a loaf of bread requires an unusually high amount of energy.

Oil is also an ingredient in the food we consume. The main food product that comes from petroleum is known as mineral oil. It’s commonly used to make foods last longer because petroleum doesn’t go rancid. Packaged baked goods like cookies and pizza often contain mineral oil as a way of preserving their shelf life.

Petrochemicals are also used to make food dyes, which can be found in cereals and candy.

Paraffin wax, a colorless or white wax made from petroleum, is used in the production of some chocolates and sprayed onto fruits to slow down spoilage and give them a glossy finish. It also helps chocolates stay solid at room temperature.

And plastic is a vital part of food packaging because it is relatively cheap, durable and lightweight, it provides protection and is sanitary.

 

Oil Inflation and the Fed

The importance of oil to the U.S. economy has been a big concern since the oil crisis of 1973, when prices spiked, prompting calls to conserve energy.

Since then, the amount of oil consumed for every dollar of economic output has declined about 40%. In 1973, for example, it took just under one barrel of oil to produce $1,000 worth of economic output. Today, it takes less than half a barrel. That’s the good news.

The bad is that, because the U.S. economy is now 18 times bigger than it was in 1973, it requires a lot more oil to function.

That’s why the surging price of oil is now the main driver of inflation – and why the Federal Reserve is preparing for some big increases in interest rates to fight it.

 

Suggested Reading

Where Investors Should Turn if Spiking Oil Prices Feed Stagflation

Enough US Produced Lithium to Exceed Today’s Demand

The Case for More US Produced Uranium

Is it Too Late to Benefit From Higher Oil?

 

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