What Canada/China’s Yuan Trade Deal Means for U.S. Dollar

How Long Will This U.S. Dollar Rally LastAs the chart below illustrates, since July of this year, the U.S. dollar has been rallying against other major world currencies.

I, for one, do not expect to see the rally in the U.S. dollar sustained. I believe the U.S. dollar is currently rallying, because other parts in the global economy are doing worse than the U.S. While the U.S. dollar may rise in the short-term, because our central bank stopped printing new paper money and other countries are still printing their currency, in the long run, I see the fundamentals of the greenback tormented.

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Chart courtesy of www.StockCharts.com

Let me explain…

Since the Great Recession, some countries started moving away from the U.S. dollar as their reserve currency—and that movement is accelerating.

In recent days, Canada signed an agreement with China where both countries ditched the greenback when it comes to their trade. Going forward, the respective countries will trade with each other in their local currencies—in Canadian dollars and Chinese yuan. This trade deal made Canada the first country in North America to deal trade in yuan. (Source: The Canadian Press, November 8, 2014.)

In the past, when countries around the world would issue bonds, they were often denominated in U.S. dollars. The reason for this was simple: the U.S. dollar was liquid and recognizable throughout the world. This is changing, too.

For the first time, the United Kingdom has issued yuan-dominated bonds. The country issued bonds worth three billion yuan. This is certainly not a big figure (equal to about USD $490 million), but the move is significant, as the U.K. tests the waters for non-U.S. dollar-denominated bonds. (Source: BusinessWeek, October 14, 2014.) As more countries follow the path of Canada, China, and the U.K. and initiate trade or sell bonds in currencies other than the U.S. dollar, this will put pressure on the value of the U.S. dollar.

Please let me be clear: the U.S. dollar will not lose its reserve currency status overnight. It will be a long process. But I believe it will happen for the following reasons: 1) China is getting closer and closer to uprooting the U.S. as the world’s biggest economy; 2) China has most of the gold; 3) the Federal Reserve will be quick to come out with QE4 if the U.S. economy (or stock market) starts to tank; and 4) the U.S. national debt will continue to rise at an accelerated rate.

If we have learned one thing about money from history it is that a paper reserve currency doesn’t remain a reserve currency forever. The U.S. dollar has had its turn as the reserve currency of the world.