Michael Every: 'War and gold won't make the dollar disappear'

The war in Ukraine caused quite a stir in the financial markets last year. Central banks were completely surprised by skyrocketing inflation, which was largely caused by war and sanctions. Investors should therefore keep an eye on geopolitical developments, but that does not mean that central banks have become irrelevant. That's what Rabobank analyst Michael Every writes this week in a new Market Commentary. He doubts that the Chinese yuan will take over the dollar's role as the world's reserve currency. He also questions a peg between the yuan and gold. How does he foresee the future of our money system?

Every's comment seems to be a direct response to the Final Analysis from Zoltan Pozsar, Credit Suisse's widely read credit analyst. Pozsar believes that we are entering an era of (economic) warfare. In that scenario, he says, the role of the dollar will come under pressure and commodities will become more important. China will try to pay for more oil in yuan, which will strengthen the international role of the Chinese currency. The petroyuan will challenge the petrodollar.

Chinese yuan as the world's reserve currency?

According to Every, these are indeed important trends, but that does not mean that the dollar system will simply disappear. He noted that the Chinese yuan is still not fully convertible and that the capital market in Chinese yuan is still a long way from being able to compete with the capital markets for dollars and euros. In addition, China has a structural budget surplus, which means that it will be difficult for other countries to build up significant yuan-denominated reserves. Also, many Gulf states have pegged their currency to the U.S. dollar, which makes it complicated to switch.

According to Every, the Chinese yuan cannot simply take over the role of the dollar as the world's reserve currency. The dollar is still anchored in the current system, even within the Chinese economy. For example, China has the largest foreign exchange reserves in the world, a significant portion of which consists of dollars in the form of U.S. government bonds. China will not want to write off these reserves just like that. And although the country has bought a lot of gold in the past twenty years, the official Chinese gold stock of almost 2,000 tonnes, only a few percent of the total reserves. China therefore has more interest in an orderly transition to a new monetary system than in a crash of the dollar system, according to the Rabobank analyst.

Peg to gold?

The idea that China can peg its yuan to gold is dismissed by Every as wishful thinking. The value of China's gold reserves is only a fraction of the amounts with which China trades with Europe and with oil producers in the Middle East. For that to happen, the gold price would have to be much higher than it is now, but the question is how much higher and how the central bank will defend that peg.

The return of gold to the monetary system requires coordination and cooperation from Western economies, which have the largest gold reserves. Every thinks that this support will not be there as long as the dollar system is still functioning. A pegging of the currency to gold could also have adverse consequences for the Chinese economy. After all, the value of the yuan will rise, so that the export-driven growth model will no longer work. Chinese products will then become much more expensive for the rest of the world.

What's next?

So Every does not expect the Chinese yuan to take over the role of the dollar any time soon, but he endorses Pozsar's analysis that (economic) warfare will lead to higher inflation. Western economies will have to further develop their industry, which requires a lot of raw materials. Moreover, a war economy withdraws means of production and capital goods from the rest of the economy, which will generally have a price-pushing effect.

Every does not expect central banks to stand idly by in this scenario. He foresees that the Federal Reserve will raise interest rates further to bring down inflation and strengthen the dollar. In his conclusion, Every writes that geopolitical developments have become important, but certainly not all-important. This may result in less exciting stories, but according to him, it does lead us to conclusions that will ultimately be closer to reality.

Watch the latest video of Paul buitink with Michael Everyday here: