Gerald Ashley: 0:00

Hello and welcome to this latest edition of Equital Conversations. My name is Gerald Ashley and I'm joined as usual by my friend and colleague, george Cooper. Today we're going to focus on the almighty dollar and the idea of the recent events around Trump and the tariffs. Is this going to shake the role of the US dollar as a reserve currency? And it's worth reminding ourselves that the US dollar has been pretty much in the driving seat since 1944 and Bretton Woods. There have certainly been some large bumps in the road since, some large bumps in the road since, but now is the big picture really starting to turn? A difficult question, so at this point I shall hand over to George.

George Cooper: 1:01

Morning, Gerald. There's a few things that have happened during this what I've started to call a tariff tantrum. There's a few things that have happened that I think are quite indicative of the dollar starting to have a few serious problems. One of them just on Friday. We had the situation where the dollar weakened sharply, even while US bond yields rose, and that was a sort of break in the normal relationship.

George Cooper: 1:26

That's pretty unusual, yeah it has happened before, but this was a particularly big break and, dare I say it, you do get that behavior in other markets, but it's consistent more with what happens with emerging markets rather than with the reserve currency.

Gerald Ashley: 1:46

Yeah, I'm going to have to stop you there, because that's a kind of a huge statement to sort of suggest that the US A, the US dollar is not performing normally and, secondly, that it's becoming a much more volatile and skittish currency that it's becoming a much more volatile and skittish currency.

George Cooper: 2:06

Yes, I mean, I don't make that comparison lightly, but you see it, for example, with currencies like the Turkish lira, when the market starts to worry about whether the Turkish government can fund its debt, so bond yields go higher and for exactly the same reason, the currency weakens. And I think this is what we're starting to sense with the US Treasury market. We know we've got a very high US fiscal deficit. I think the federal deficit is currently running at about 8.8% of GDP, which is that's consistent with the sort of level of deficit that was required to deal with the global financial crisis, yeah, and then we're kind of in the danger zone in that sense.

George Cooper: 2:59

Yeah, so we are running at serious crisis level in the deficit at a time when we think the economy is performing quite normally. So if we ask ourselves the sort of counterfactual, what sort of deficit level is going to be necessary if we do go into a bigger crisis? You know, are we going to be at, I don't know, 16% of GDP, something really, really huge. And I think that's coming at a time when Trump has arguably, let's say, discouraged the natural buyers of treasuries.

Gerald Ashley: 3:44

When I was going to suggest he's upended everything. I may feel slightly calmer in my views and assessment a week than, say, a week ago, but you know the rules of the game do not seem so solid. It might just be worth just very briefly looking over the last 75 years. As I mentioned, we had Bretton Woods in 1944, currencies pegged to the dollar and convertible into gold, and of course I'm sure we'll come up to gold in a few minutes time. Nixon, effectively, was forced off that relationship with gold in 1971. I think the costs of Vietnam War and costs in general were just too much. The system then has worked, but it hasn't been perfect, has it? Because we've had a number of uh shocks, um, in just the world of currencies, two or three big realignments of the dollar against other currencies, um, but where we are now, it would be a significant step change to say that the us dollar is just going to be a another currency yeah, it would be huge.

George Cooper: 5:04

I mean, it would upend all of the sort of norms of financial markets that we've all grown up with. I mean, if we go back to 1971, when Nixon effectively took the world off the gold standard, as it turned out, he took the world off the gold standard, but he put it on onto the dollar standard, so the dollar actually became even more important after 1971. And what I'm now wondering is has Trump now taken it off, taken the world off the dollar standard, and we're going to go to something else, and that something else is well, at the moment it's difficult to see what it could be well.

Gerald Ashley: 5:49

I wonder, I wonder if, um, like a lot of things in life, they don't end with a bang but they end with a whimper. And if we look at the history of sterling as a reserve currency, um, it went from being a very profitable exercise. I mean, we should point out out that there are a lot of benefits of reserve currency status normally lower borrowing costs, this wonderful old medieval word, seigneurage I think I'm pronouncing that correctly which is basically you make money from printing your own currency and nobody gives that up lightly. But over time and this happened with Britain the reserve currency status became a huge burden because our economy was not big enough and we were left with the so called sterling area, and it was, it was a kind of stuck around our necks. I I would suggest that we're not at anywhere near that stage yet..

George Cooper: 6:50

Maybe we should say you know, peak dollar as a reserve currency has happened well, you know, I think pretty much everybody in the financial markets have got a fair amount of criticism of the handling of the tariff event in the last few weeks. But to give Donald Trump some credit, I think he has correctly identified the cost of being the reserve currency. And that is the cost of being the reserve currency. And that is, over time. It does exactly what you say, gerald it. It helps you, it keeps the currency strong, it lowers your borrowing costs. But because it keeps the currency strong, it also makes you uncompetitive for your manufacturing industries so effectively.

George Cooper: 7:45

One of the benefits of being the reserve currency is that the rest of the world manufactures for you and gives you the goods and in return you give them printed money. Yeah, so you know that's, in a sense, that's a great deal. You get stuff for free. It does sound a very good deal. I must say, yeah, you know, it's more or less for free. You know you can think of it as I don't know, sort of the king getting his tributes. But over time that does mean that your industrial strength decays and it sort of has a natural lifetime because you only get to keep the reserve currency status by being economically dominant. And, frankly, what comes with the economic dominance, military dominance, and If the reserve currency status erodes the economic dominance, then it sort of comes to a natural end. And I think Trump has effectively recognized that. He can see that the depletion of American manufacturing and industry has now gone too far and it's no longer so. America isn't the economic dominant partner anymore and that means you start to question whether it can be the military dominant partner.

Gerald Ashley: 9:15

I'm always prone to parallels and I'm going to do this again. This is a little bit like the UK at the turn into the 20th century, germany became a rising military and industrial power and the United States saw unbelievable economic and industrial growth after the American Civil War and pretty much by the time of the First World War. And that pretty much by the time of the First World War the UK was in retrospect, was probably starting in relative terms to slip back, and then you could take the view that it slid for 100 years in one way or another. And obviously it wasn't Germany that emerged, but again, I think simply because of the size of the American economy, it was pretty clear by the 1920s that the United States was going to pick up the battle, if you like, of the reserve currency.

Gerald Ashley: 10:19

Now we're talking decades there, and I know there is a tendency for guys like us, who look at financial markets in minute detail, to sometimes compress timeframes, but we might be talking about a very long time here before the dollar slips away, or what do you sense?

George Cooper: 10:41

Yeah, look, it's not going to happen overnight. It's still very clear that the us is the most important currency. I think it's no longer clear that the us is the most important economy. I I think that has changed in the last few days. Frankly, that that's very interesting. Yeah, you know the. The fact that, uh, the fact that President Trump has had to pull back on the tariffs against China on a lot of the goods, whereas China could more or less just sit quietly and wait for events to unfold, that's an important psychological shift. In fact, one of the guys in the office last week made a very interesting comparison. He said what we've just seen is the equivalent for the US of the Suez crisis for Britain. Interesting, I mean. Clearly there were very different events, but the Suez Crisis for Britain was, I think, in a lot of people's minds, the moment at which you realised Britain is no longer a dominant superpower.

Gerald Ashley: 12:01

The game was up basically.

George Cooper: 12:03

Yeah, and so he drew that parallel which had me sort of you know it caused me to sort of pause, think is that right, is that a valid parallel or not?

Gerald Ashley: 12:18

Well, I think, if we look at the current situation, the numbers still favor the US in terms of trade dominance. I picked up some data before doing this podcast and around 85% 86% of all international transactions are settled in dollars. As we know, it's still the primary currency for commodities. One always thinks of oil being priced in dollars, etc. And I don't know if we should just alight upon the view that US Treasury securities are seen as the safest assets globally. Lots of foreign holders people always talk a lot about what percentage of holding is actually held by the Chinese and the US needs to issue a lot of paper, needs to issue a lot of debt constantly, and I think I have a number right that over the next year or so, they've got to refund or refinance somewhere around $3 trillion US, and that is going to be the short-term thing that's going to focus everybody's attention.

George Cooper: 13:45

I would have thought yeah, I think the financial position of the US government is now front and centre and there's a few things that have caught my attention lately. The first thing is the DOGE program, the Department of Government Efficiency. It looks like it's not succeeding. If you look at the run rate of government spending in Trump's presidency versus Biden, it looks like the Trump government is actually spending slightly faster, slightly more than the previous administration, and that's despite all the ballyhoo and great newspaper headlines of, you know, fraudulent activity which, against the full scale of spending, is probably quite a small percentage scale of spending is probably quite a small percentage.

George Cooper: 14:46

Yeah, so it's. It's gone from an expectation of of saving. I think the original claim was two trillion down to one trillion, and now it's claiming it looks like it's going to be maybe a few hundred million billion.

Gerald Ashley: 14:58

Um, sorry, billion. Yeah, we've given up with billions, george.

George Cooper: 15:02

Yeah, and on the other side of it, the US government has just approved a $1 trillion defence budget, so that's a big step up.

Gerald Ashley: 15:18

I think the previous one was $892 billion, and of course that trillion number is pretty much where the interest bill is as well.

George Cooper: 15:26

there's the interest bill absolutely, which is again after last week, is just getting higher and higher, so all of these things are sort of stacking up to being a problem. At the same time, president Trump has discouraged the buyers of treasuries. Let's put it that way I'm trying to be as polite as possible he certainly made it less appealing to hold treasuries as an asset from a geopolitical point of view. He's also effectively saying, with his focus on trade and here it's not a criticism of his focus on trade, because I think he has to do it but in focusing on trade and saying he doesn't want trade deficits with other countries, he's effectively saying he needs a weaker dollar.

Gerald Ashley: 16:22

Yeah, absolutely.

George Cooper: 16:24

So if you're going to buy treasuries with a big government deficit and an expectation of a weakening dollar, well, what are you getting for your money?

Gerald Ashley: 16:37

Well, you're getting a kind of instant markdown if you're not very careful.

George Cooper: 16:41

Yeah, so yeah, and all of this, you put it all together and the one asset that now everybody's suddenly talking about, gold. Gold is effectively the measure of what's going on here. Gold is saying hang on, we have a problem in the fiscal situation of the US, and I should say it's not just the US, it's pretty much all Western not even Western, it's all developed economies have this problem, which is why I think you're right, gerald the US dollar will still be the most important currency in several years time because, frankly, the rest of them have similar problems.

Gerald Ashley: 17:34

Yeah. So, unlike my earlier historical analogy, the rising economy being strong in the form of the US versus sterling, maybe there isn't anybody to obviously fill the gap. I mean, there are lots of people bang the drum of well, now is the time for some realignment of all this sort of currency regime. Some people have advocated the idea that the BRICs are going to go off and have some sort of informal currency arrangement or, at the very least, they're going to not boycott the dollar, but they're going to downgrade how much they use the dollar in their trade. As ever, in these things, I think it's always useful to see what people do rather than what they say, and I mean.

Gerald Ashley: 18:32

To me, the BRICS are not really particularly enamored of one another. It's just that they would like the idea of the dollar not being so dominant. Perhaps I should just have said bricks is the, the term that was coined, I think 20 years ago by goldmans um of brazil, russia, india, china, and I think the s is um is south africa, and I can't I think you're right yeah, I can't imagine why they included that, to be honest, but I and so it was a.

Gerald Ashley: 19:04

it's a simple mnemonic for how to look at those countries, but the big boys are obviously China and India, but I don't see them getting together to try and replace the dollar.

George Cooper: 19:15

No, I would agree, the BRICS is not really a natural geopolitical unit, but it's. The members of the bricks and others are being effectively corralled together, in part by the behavior of of america. I mean, you know, as I think I've said before, when you get to the point when you've peed off canada, yeah, you know they, you, you've got to be working pretty hard.

Gerald Ashley: 19:45

And they're pretty mild-mannered folk by all accounts, yeah.

George Cooper: 19:50

When Canada and Denmark are annoyed, then I think you've got to actually step back and say what's going on here.

Gerald Ashley: 20:01

What's going on here? Now, if we're running the US administration, we've got a very difficult circle to square, if that's the correct way of putting it. We'd like, maybe, for the dollar to be weaker, but we've got to somehow fund all this expenditure. The yield curve is our enemy, in the sense it's going the wrong way that the long end is saying borrowing costs are going to go up and the interest rate bill is going to go up, and this is going to make it even harder to cut expenditure. So, to use the well-worn phrase, what's going to give the Fed's balance sheet.

George Cooper: 20:46

I think I think in this situation, the Fed has to become the buyer of, maybe first and last resort for the treasury market. So I think, ultimately, we're going to be looking at more quantitative easing.

Gerald Ashley: 21:03

So we're back to 2010, 11, 12 again. In that sense.

George Cooper: 21:07

Yeah, I think so. Probably in bigger size, and maybe that will come with some more exotic flavors of QE, like Operation Twist, where they try to bring the long end of the bond market down, which they can do with direct purchases or they can do with effectively threatened purchases. They can say, right, we'll sit on the bid above 5% yield or something like that, and then, if they do that right, they might get away without actually needing to buy that many treasuries because the market won't try to push the yields above anyway, It'll be known as going to be an operation.

George Cooper: 22:03

It's going to be a quantitative easing operation. That's needed, and, of course, we use words like quantitative easing because they're a lovely euphemism. The real word is monetization. That's what it means. The governments are going to be printing money to pay their bills and that's going to be uh, I think it's going to continue to push other safe haven assets higher, like gold. Um, who knows, it could even carry on supporting Bitcoin. In fact, we should have a little discussion on Bitcoin and stablecoins, because I think they're an interesting little sideshow to this.

Gerald Ashley: 22:54

I'm going to hit the pause button before you get to that and say that. So we're going to see interest rates fall quite a great deal at the short end, do you think?

George Cooper: 23:05

uh, I would expect so.

Gerald Ashley: 23:06

Yes, and that's going to be a challenge because, well, with the background, I was just going to say with the background of inflation, where it is, that's yeah, it may.

George Cooper: 23:15

inflation I can. I can. I can tell myself plausible stories that sends inflation in both directions. Here the tariffs as enacted originally were clearly going to be inflationary, but because he's pulled back on a lot of the tariff threats and probably damaged investment spending and confidence, you could actually see a sort of disinflationary impetus coming out of this. And what nobody has been focusing on during the last couple of weeks, or haven't really focused on as much as they should, is the oil prices has fallen very sharply, so that's a disinflationary thing. So there may be a more orderly sort of escape path here that inflation falls and that gives the Fed the fig leaf to cut rates. And then I think even by cutting rates they're still going to have to end up monetizing.

Gerald Ashley: 24:23

So I can see that as a sort of and then we're faced with the longer term challenge of getting off QE and another inflationary bubble that will pop up as a result, I would imagine.

George Cooper: 24:37

Yeah, I mean, I suspect that's just another round of QE, is just another stepping stone towards dealing with the bigger challenge, which is, ultimately, governments have to get their deficits, they have to get their deficits, they have to get their spending back in line with their income. Yeah, and I find, as somebody who likes to sort of observe the different tribes of economists coming in and out of fashion, one of the things that has amused me in the last couple of months is how you just don't hear from the MMT people anymore.

Gerald Ashley: 25:22

Oh no, the magic money tree stuff.

George Cooper: 25:26

Yeah, the modern monetary theorists.

Gerald Ashley: 25:28

I prefer my description.

George Cooper: 25:30

Yeah, the magic money tree, people who've been telling us for years that governments can spend an unlimited amount of money, deficits don't matter and you don't need to tax to fund your deficit. Suddenly they've vanished from the narrative.

Gerald Ashley: 25:50

But yeah, I mean, no doubt there are cycles in these things and they will come back. I slightly cut you off on the idea of talking about Bitcoins and stablecoins and in this last few minutes of us observing the overall landscape of things just as an outsider on this. Well, bitcoin fell a great deal. It was more like an equity than as a currency.

George Cooper: 26:17

Um, yeah, a bit. Bitcoin sometimes trades like a sort of leveraged version of the nasdaq um and I and I think that's sort of how it's behaved this time. But the one, the part of the um digital currencies that interests me more than bitcoin is actually the stable coins, because I think there's an interesting, uh sort of element to the stable coin which is basically they're backed by a dollar somewhere behind the coin.

Gerald Ashley: 26:54

There's a dollar yeah, yeah, I.

George Cooper: 26:56

I think what's happening with the stable coins and this explains why they're they're getting a sort of tacit approval from, uh, from authorities is, if you dig into what you're you're buying when you buy a stable coin, most of the time what you're buying is a US treasury stable dollar fund, so you're buying a US money market fund that invests in treasuries.

Gerald Ashley: 27:23

And it's got a nice sexy crypto wrap around it.

George Cooper: 27:26

Exactly. So what stable coins do is they turn probably the dullest investment in financial markets, which is T-bills, into something sexy. It's a brilliant, brilliant marketing exercise. You know, it's a sort of….

Gerald Ashley: 27:46

And very successful by all accounts. The issuance has been huge.

George Cooper: 27:50

Yeah. So there's a lot of things, a lot of steps taken by the administration recently. Tariffs is one, the Doge program is another, telling Europe it wants to reduce its military presence in Europe. They're all consistent with a recognition that the US needs to get its spending down, and I think the promotion of digital currencies, of cryptocurrency, sorry and especially of stable coins, that's very consistent with them looking for a way of effectively marketing treasuries marketing treasuries, as you say traditionally, or maybe the traditional selling elements have been weakened.

Gerald Ashley: 28:43

As we talked about the value of the dollar and the overall performance of the US vis-a-vis China, we're kind of coming towards the end of this sort of run around what may be the start of a whole new era in finance. I think we both agree. If it is the start, there will be decades of change to come. This isn't something that's all going to be settled by the summer. Having looked at all that goes on, we're now left with our last little final section. We always talk about uh books, uh, to recommend um.

Gerald Ashley: 29:21

I'm going to go first with a book that I was given as a gift last year and wasn't aware of, but I I really, really like this financial book. It's called money and promises. It's by an italian, uholo Zanoni, who's something of a polymath. He's a serious academic who's had a strong career in investment banking and also in Italian industry, and he just explains in very, very simple terms how banks get created, how they create credit, how this helps economies and how, ultimately, banks can be very dangerous institutions if they're not properly uh, properly regulated and and watched um.

Gerald Ashley: 30:07

He starts with looking at the ledger entries of a bank from medieval pisa, actual documents of early uh, early entries. From memory I think there's something like 24, 25 initial entries in this ledger that has been saved from all those centuries and it just illustrates how banks essentially create what Keynes would have called bank money or credit. It's a very easy read. It's not remotely technical. People who like financial history, like myself, will really like it, but it's pretty good for the general reader. I'll leave you with the second recommendation to wind us up with George Okay to wind us up with George.

George Cooper: 30:54

Okay, well, gerald, I'm going to go with one of my favorite behavioral books, if you like analysis of human behavior, and that's a book called Deceit and Self-Deception by Robert Trivers. This book I find really interesting because what Robert Trivers explains is how and why we lie to ourselves. And he explains it in great detail, explains how there are some very important evolutionary advantages to lying to ourselves. So we don't actually know it, we don't know that we're lying to ourselves, so we don't actually know it. We don't know that we're lying to ourselves. But to be more precise, he explains that sometimes we may know something to be true but we bury it in our subconscious. If we consciously believe the lie, it helps us deceive others.

Gerald Ashley: 32:02

So there's a comparative advantage.

George Cooper: 32:04

Yes, and that can be useful. So if, for example, we've been dishonest and we convince ourselves we haven't been, then we can effectively get away with it more easily. So we tell ourselves we've been honest. But the research because he's a serious academic, this guy, but the research he describes is fascinating. But he's also got a few really useful sort of tidbits in there on how you can tell if you're being lied to.

George Cooper: 32:40

Oh right, oh, this does sound good yeah, so that's kind of useful. So one of the things he points out is lying requires more thinking than telling the truth, so you get a higher what he calls cognitive load. You have to think about what you're saying when you're lying, isn't the yeah?

Gerald Ashley: 32:58

it's the old phrase that liars need good memories as well. Yeah.

George Cooper: 33:03

And he said and one of the symptoms of that is, contrary to popular belief, one of the things we do when we're lying is we tend to blink less. One of the things we do when we're lying is we tend to blink less because we're concentrating so much on the process of lying. So yeah, well worth a read. Interesting book.

Gerald Ashley: 33:24

Yeah. So your hot tip is if you're lying is to make sure you keep blinking. Yes, to counteract the body signals. George, thank you very much. We've covered a lot, I think, in the last half an hour or so, and there's plenty going on in the world, so we'll have plenty to talk to at future episodes, but for now it's goodbye from me.

George Cooper: 33:50

And goodbye from me. I'm sure we'll be revisiting this topic again in the not-too-distant future. Thank you, Gerald.

Gerald Ashley: 33:57

Thank you.