The Yellow Brick Road

This is the follow-up after my post on the role of the dollar as the international reserve currency. I was arguing that the logic of the world trade was pulling the dollar out of United States to facilitate all foreign transactions and that had an adverse effect of forcing the huge trade deficit. I was also suggesting that the World is not ready to make any bold move on the dollar as long as the world is in recession and then in weak recovery. Nothing will happen until the recovery becomes strong enough to finally push the dollar away.

In the meantime, the only way for the second-largest economic force in the world, China, to avoid the dollar in its trades are currency swaps.

Here’s the Google trend chart for currency swaps search:

There are some upticks later on but nothing major. Yet.

The additional search reveiled an interesting article:

China is trying to enter into currency-swap agreements with countries like Argentina, Brazil, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. It has signed agreements worth $95 billion in the last four months

The monthly trade amount between Brazil and China is $3.2 bln, so the size of this swap agreement is sufficiently huge. It probably will be sufficient to take over 50% of the trade between China and those countries listed.

Nouriel Roubini, one of the few economists who correctly predicted the current financial crisis, recently wrote, “Traditionally, empires that hold the global reserve currency are also net foreign creditors and net lenders. The British Empire declined — and the pound lost its status as the main global reserve currency — when Britain became a net debtor and a net borrower in World War II. Today, the United States is in a similar position. It is running huge budget and trade deficits, and is relying on the kindness of restless foreign creditors who are starting to feel uneasy about accumulating even more dollar assets. The resulting downfall of the dollar may be only a matter of time… China has already flexed its muscle by setting up currency swaps with several countries.”"

So what I want to point here is a large disproportion between the significance of those swaps and the interest to them from the online community.

I claim that the currency swaps is the single most important development in the international trade. But it will take a year or two before everybody will get this.

And I want to remind you about my call for W-shaped recession, where the second decline will be attributed to the demotion of the dollar from the status of the single reserve currency. I would put a 2-3 years timeline before it becomes painfully obvious with the consequences of pushing us into second recession soon after the first one ends.

And this is when the Dow will finally get into that 3,600 area.