FXY - The U.S. Dollar Under Attack

• Why investors should pay attention to the U.S. dollar.
• Weaponizing the currency is a double-edged weapon.
• There are many threats to dollar dominance.
• What will happen when the greenback depreciates.
• Hedging against depreciation.

Why Concentrate On The U.S. Dollar

The U.S. dollar is the most important currency in global markets. The strength of the dollar has advantages that have made Americans prosperous. Imports cost less if the greenback fetches a lot of foreign currency. On the other hand, it is interesting for companies to outsource production in order to increase profits by exploiting cheap labor in other countries instead of paying expensive salaries to American workers. Outsourcing is good for investors since higher company profits usually result in higher prices for company stocks as well as higher dividends It seemed that globalization was a good idea until the Covid-19 pandemic upset supply chains and created logistical bottlenecks. Investors should take that into account.

Given that imports are relatively inexpensive for Americans, the amount of imports has increased while the amount of exports from the USA has not kept pace. The problem is that the expensive U.S. dollar makes production in the U.S. more costly, which leads to outsourcing of production and a consequent increase in imports as the finished low-cost goods are sent to the U.S. for retail sale. Some industries manage to maintain their global position, for instance, weapons and medical equipment. In fact, due to the huge defense budget, weapons makers are a good investment. The conflict in Ukraine is really a bonanza for the weapons industry.

One result of the huge deficit in the trade balance is that large sums of dollars end up in the hands of foreigners. One way foreign entities can employ their dollars is to buy U.S. Treasury paper. China and Japan hold extraordinarily large sums of U.S. debt There is also the problem of Federal budget deficits, which are covered by monetization of the debt. The Fed ends up buying Treasury paper and had over $9 trillion on its balance sheet. At the same time, the Fed is now raising interest rates in order to stem inflation. This has the result of making American debt more attractive in the global market, which means that the greenback becomes stronger in Forex markets. The contradiction that high inflation in the U.S. causes the currency to appreciate in Forex markets means that the trade balance deficit is likely to increase as imports continue to be inexpensive and put more dollars in circulation globally.

Under such conditions, it seems that the U.S. dollar is going to continue being the main global currency. This would discourage investors from changing dollars into foreign currencies like the Euro, which has depreciated against the U.S. currency and is now practically at par with the greenback. Most other fiat currencies have lost value vis-a-vis the dollar. The Japanese Yen has also weakened against the dollar. See a good article about dollar dominance over the Euro and Yen. ( Despite Our Own Inflation, The Dollar Dominance Takes Down The Yen And Euro .)

The Swiss franc has held up fairly well while the Russian ruble has surprisingly not been destroyed by the sanctions imposed after the Russian incursion in Ukraine.

One can thus see that a strong dollar helps to make Americans prosperous. Investing in foreign fiat currencies becomes risky as the greenback continues to appreciate and other currencies depreciate against the dollar. At the same time, the U.S. becomes dependent on goods being imported, and depreciation of the currency could be a serious concern for the population. In conclusion, there are several reasons why it behooves investors to pay attention to the health of the dollar. A lot depends on the strength of the U.S. dollar.

Weaponization Of The Currency

Using the currency as a weapon is nothing new. The U.S. has imposed sanctions on Cuba, Iran, North Korea, Russia, Syria and Venezuela among others. One could argue that Cuba and North Korea are economic dwarfs and that therefore imposing sanctions would have little effect on the US dollar. Iran and Syria are also hardly threats to dollar dominance. Venezuela has a lot of oil but is weak economically. The case of Russia, a nuclear power, is different. The attempt to ruin the Russian economy by imposing sanctions as a means to convince the Russians to give up their military operation in Ukraine does not seem to have been successful so far. Russia has started demanding payment in rubles for gas and oil, with the result that the ruble is surprisingly strong in Forex markets.

Another effect of the weaponization of the currency is that Russia and China have drawn closer together and have increased the amount of trade between themselves. This trade largely avoids the U.S. dollar as a means of exchange. In fact, the Chinese and Russians have created financial systems of payment that avoid the U.S. dollar. This means that demand for dollars accordingly decreases. The idea that countries can have bilateral trade agreements that allow them to avoid the use of dollars could turn out to be a real menace for dollar domination. Russia and Turkey have made agreements that circumvent the use of U.S. dollars Russia and Turkey reach deal to ditch dollar in trade

It, therefore, seems that weaponization of the currency can lead to countries trying to avoid use of the dollar system in order to escape from undue influence of the U.S. on their foreign policy.

Threats To Dollar Dominance

This writer has published several articles about the dollar, which can be seen on Seeking Alpha. One can simply search WWS Swiss Financial Consulting SA on Seeking Alpha. The increasing federal debt (now over $30.6 trillion), the federal budget deficits, the huge balance of trade deficit and inflation do not help to create trust in the currency. Weaponization of the currency has led several countries to seek ways to avoid use of the U.S. dollar, notably China and Russia. Iran has managed to sell oil despite sanctions. The more other countries try avoiding the dollar financial system, the less demand there will be for dollars in Forex markets. It is probable that the growth of Eastern economies will put an end to dollar dominance. That remains to be seen, of course.

The position of Saudi Arabia is key to dollar dominance as the petrodollar is basic to the dollar's role in global finance. Should the Saudis agree to accept payment for gas and oil in a currency other than U.S. dollars, things will change rapidly in Forex markets. The point here is that dollar dominance is not a permanent feature of global finance and that there are developments that favor an end of the current situation.

Greenback Depreciation

One can speculate on what would happen should the U.S. currency markedly depreciate. Imports would become much more expensive. It would take some years before production of goods could be brought back to the U.S. It takes capital and time to build factories and train workers in order to recover market share. Foreign investors would avoid investing in the U.S. due to hyperinflation and rapid depreciation in Forex markets. This would result in further monetization of the currency and more and more inflation. The Government might not be able to finance the federal debt and then default on Treasury debt. Hopefully, such a catastrophic situation will not come about.

How Investors Should Hedge Against Dollar Depreciation

This is a rather difficult topic and should be the subject of a separate article. There are so many variables involved in addition to uncertainty about the future that investors might wish not to worry about it at the present time. If China and Russia are really working on a gold-based CBDC (Central Bank Digital Currency), then the U.S. might not have any problem at all since the amount of gold that the Government is supposed to have, namely over 8,100 tons, would mean that the Fed could put out a gold-based CBDC that would continue U.S. dollar dominance. Physical gold, stocks of gold mining companies, and stocks of gold royalty companies could be good hedges if the dollar depreciates.

Commodities are extremely risky investments and require great care before putting cash on the line. There can be great surprises in commodity trading. Food looks like it is going to become more expensive, and oil will remain in demand.

Real estate can be useful in protecting wealth in an inflationary environment. Before investing in REITs. however, one has to do one's research in order to ascertain if the company has a solid foundation.

In conclusion, investors are going to have to work harder to protect their wealth. Buying and holding stocks is not going to be the best way to come out ahead.

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