In his latest Strategy Monthly, Louis-Vincent Gave writes...
Investors will be happy to bid farewell to 2018, a miserable year in which all assets underperformed US dollar cash.
But, Gave notes that for next year, three questions are critical:
1) Will the US-dollar liquidity squeeze ease?
2) Will the expanding US budget deficit prove a decisive factor? and
3) Are we witnessing the slow-motion unraveling of the “Chimerica” synergy between the US and China?
And what they imply is critical:
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Option 1: A Liquidity Squeeze (And How It Ends)
Does oil start a chain reaction leading to an easier Fed?
Option 2: Growing US Budget Deficits Are Crowing-Out The Private Sector
Despite record-high tax receipts, the US budget deficit once again expanded in 2018. This is unprecedented. We have never seen consecutive deficit expansions outside of a recession.
So what happens next? Will the US government:
1) Shrink spending,
2) increased tax revenues, or
3) continue to expand deficits?
And if so, then will easy fiscal/easy money mix end the deflationary era?
This would have massive consequences for portfolio construction - long bonds did terribly, and equity portfolios were best hedged by gold.
Option 3: The End Of "Chimerica"
This year's single most-important event has been the rise in China-US tensions. Are these tensions:
1. A by-product of President Trump's negotiating methods, so that by April a deal will be struck which brings us back to something approaching the previous status quo? Or,
2. The direct consequence of the fact that so many Trump advisors see China as a long-term threat to the US and want China cut down to size through an economic cold war?
China's response: de-dollarization
China remains highly dependent on resource imports priced in US dollars. To reduce its dollar-dependence at a time of rising conflict with the US, and to advance its own imperial ambitions, China has an incentive to de-dollarize commodity prices, and promote greater use of the renminbi.
To shift Asian trade and commodities pricing away from the US dollar, the renminbi needs to be a credible alternative.
One step in this direction is establishing a track record for the renminbi as a strong currency - as illustrated by the strong returns of renminbi cash over the past two decades. Another is the creation of renminbi-denominated oil futures and gold futures.
Which raises the question - Is the renminbi managed against a basket? Or against gold?
An interesting side-note on the renminbi: It fell sharply this summer, not only against the dollar, but against the CFETS trade-weighted basket that is supposedly the target of PBOC policy. Yet it barely moved against gold...
This could be a coincidence - or evidence of Beijing's long-term plan of de-dollarizing commodity prices.
By linking the renminbi to gold, even if loosely, it can crate an alternative for international payments, without losing control of its currency.
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