(Kitco News) - Talking about the demise of the U.S. dollar as the world’s reserve currency and the end of American exceptionalism sounds very alarmist. While it might be an exaggeration, I don’t think there is another way to explain what has happened in financial markets this past week.
As analysts and economists were preparing for Trump’s global import taxes, many started talking about a proposal floating that would usher in a new global dynamic where the U.S. economy enjoys new trade deals: In return for global economic stability and security, nations would agree to keep a weak U.S. dollar.
Achieving what some dubbed the Mar-a-Lago Accord would require a global agreement; however, the risk was always that America-First policies quickly devolve into America-alone policies.
As these risks begin to materialize, investors have been hyper-focused on freefalling equity markets. Yet, it has been the selloff in U.S. bonds this week that was the real crisis.
The 10-year yield is ending the week at 4.5% and saw one of its biggest jumps on record. This may not sound like much, but U.S. bonds are the pillar of the global economy, and everything from mortgage rates to corporate bonds and junk bonds is priced off this benchmark.
A sharp 59 basis point rise in a few days causes mass repricing in several different markets and increases borrowing costs across the board.
This is chaos in the purest sense.
With fear surging through global financial markets, U.S. bond yields should be falling. When everyone is scared, they see U.S. bonds and the U.S. dollar as safe-haven assets.
However, that dramatically changed this week as many nations no longer see the U.S. as a reliable trading partner. While the reserve currency system won’t fall apart overnight, it does lead me to my main focus: gold.
The U.S. dollar will remain the world’s reserve currency for decades to come, but that doesn’t mean there won’t be competition in a new multi-polar currency world. However, there is only one international monetary asset that has no geopolitical or third-party risk.
This is what we saw this week. Equities, the U.S. dollar, and bonds sold off, but gold prices ended the week above $3,200 with a 6% gain.
What is interesting about gold is that while people are saying the market is starting to look frothy and overbought, nobody is expecting to see any dramatic selloff. Despite this week's dramatic rally, gold remains an attractive asset to own because of all the uncertainty. For now, it is one of the few safe-haven assets standing.
For investors wondering how far this rally could go, there is still one more shoe to drop. The U.S. government, with its massive debt, can’t afford higher bond yields.
Should the 10-year push closer to 5%, the Federal Reserve could be forced to completely abandon its quantitative tightening strategy and announce new quantitative easing measures to become the buyer of last resort for bonds.
Forget easing interest rates; growth in the Federal Reserve’s balance sheet could ignite an even bigger rally in gold.
In this scenario, I would expect analysts to start talking about inflation-adjusted all-time highs, which come in at around $3,450 an ounce.
That’s it for this week. Have a great weekend.
