What if the Dollar Takes a Dive?

By Andrew Willms, President & CEO

The U.S. dollar has long been regarded as the world’s reserve currency and a store of value. Not surprisingly, the dollar soared to a three-and-a-half year high in March as the coronavirus roiled the world.

The pandemic is still lurking, but the dollar’s outlook has changed. The catalyst: our federal government’s attempts to ward off a coronavirus-triggered recession have raised questions about the greenback’s preeminent standing amongst the world’s currencies. Consider:

  • The Federal Reserve’s recent quantitative easing monetary policies have already added almost $3 trillion to its balance sheet since February. In addition, the Fed has committed itself to keeping interest rates lower for longer, which has brought the yield on Treasuries more in line with government debt of other developed countries. [1]

  • Not to be outdone, Washington has adopted fiscal policies that have tripled the size of the federal deficit, and both the President and Congress have promised that more stimulus is on the way.

The unprecedented increase in the amount of the U.S. dollars in circulation is almost certainly a major reason for the stock market’s ongoing rally at a time when both the U.S. and the global economies may be on the precipice.

Meanwhile, the dollar has been dropping steadily as the United States’ inability to control the spread of the virus has investors worried that America will lag the global economy. That, along with the growing Treasury debt and the need to monetize that debt, has contributed to the dollar falling by 4.4% in July alone, which amounts to the dollar’s largest one month drop since 2011.

The dollar’s decline to date in and of itself is not cause for alarm, and is actually welcomed in some circles because a weaker dollar makes American made goods cheaper, which in turn helps lessen the trade deficit. And let’s not forget that in the short run forex volatility can be high, even for the world’s reserve currency.

Nonetheless, there are macroeconomic risk factors in play. If Washington continues to try and use new dollars rather than hand sanitizer, face masks, and social distancing to control the pandemic, the anti-dollar momentum could begin to feed on itself. If that were to happen, the consequences could be quite severe.

Don’t misunderstand; I am not predicting the sky is falling. After all, people have been predicting the dollar’s collapse for decades. Nonetheless, it may make sense to consider some measured precautions against the possibility that the dollar’s fall will continue.

  • Investing in gold and other precious metals has long been considered an effective way to hedge against the dollar’s decline. That certainly has been the case with gold as of late -- the metal has soared to all-time highs in recent days. But investing in gold introduces new risks, as I discuss here. Some of these hurdles can be avoided by investing in gold and other precious metals ETFs.

  • If the dollar weakens, dollar denominated debt such as U.S. Treasuries could suffer, especially long-term bonds. As a result, thought might be given to lowering allocations to this asset class.

  • Foreign stocks will benefit if it turns out that Europe and other countries’ economies do in fact rebound faster than the U.S. Meantime, foreign bonds will benefit if the dollar falls in relation to the currency in which those bonds are denominated. Therefore, boosting allocations to foreign shares and fixed income may prove to be beneficial.

  • Similarly, you might want investing in U.S. companies that have a strong overseas presence. American businesses that derive a good deal of revenue from international operations may be less vulnerable to a falling dollar.

As the old adage goes, an ounce of prevention can be worth a pound of cure.

[1] Other actions by the Fed have boosted the dollar’s position in the global economy. For instance, The Fed extended swap lines to credit-worthy foreign central banks, sending a clear message that the Fed would intervene when necessary. This had a material calming effect and strengthened the dollar’s position as the world’s reserve currency.

Recommended Reading:

Goldman Warns the Dollar's Grip on Global Markets Might Be Over

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