By Tim Courtney, Chief Investment Officer
The threat of “de-dollarization” has been making headlines recently.1 This refers to the potential phasing out of the U.S. dollar as the global reserve currency, i.e., its utilization to conduct most important international and debt transactions. The dollar has enjoyed reserve status since roughly the end of World War II,2 thanks to the size, strength and stability of the U.S. economy during that time.
Even though the dollar has relatively good standing against a basket of foreign currencies, we consider all currencies to be speculative assets in that their value is completely determined by supply and demand. The built-in demand provided by the dollar’s reserve status gives the dollar a special advantage compared to other currencies.
This has been jeopardized in recent years by U.S. government and Fed measures to ramp up the dollar supply through stimulus checks,3 Paycheck Protection Program loans4 and quantitative easing.5 In fact, our M2 money supply increased by more than 40% between February 2020 and July 2022.6
Fortunately, demand for dollars has continued to rise in the pandemic era to meet the increased supply. The risk is, what happens if that worldwide demand declines significantly? The immediate risk is relatively low due to the confidence that global investors retain in the dollar, but it’s still a growing concern — and that’s partly because we haven’t been very good stewards of the global reserve currency.
Consider if the shoe were on the other foot. For instance, let’s say that the yuan was the world’s reserve currency and China suddenly created an enormous amount of it to distribute to their own people and companies, while we had to earn the currency the hard way. We’d probably be unhappy and incentivized to look for alternatives.
Recent U.S. fiscal behavior might be speeding up the day where de-dollarization eventually occurs, because we’re giving other countries, entities and markets every incentive to find a viable alternative.7 At the moment, no clear competitor has emerged. But it would behoove us to behave in a way that shows the world we are good stewards and follow prudent currency policies.
From an investor standpoint, the best approach to this situation is the same way to address most investing considerations — through diversification. In addition to diversifying portfolios in terms of asset types, sectors, industries and durations, we suggest ensuring that portfolios are not entirely denominated in dollars but rather incorporate other currencies and real assets as well. If you have any questions, please contact your Exencial advisor.
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