Another Rough Week for the Dollar
In last week’s HAI, it was noted that the US dollar delivered its worst weekly decline of 2021. This week, the greenback suffered further downside. This weakness raises the question of whether the recent new-year rally in the dollar has run its course. If the dollar’s rally since January was just a retracement within the larger decline that began a year ago during the Covid crisis, a continuation lower from here would act as a wind at the back of hard assets. The now two-week bout of greenback weakness provides an opportune time to examine some of the dynamics affecting the US currency.
As the world’s de facto reserve currency, the US dollar relies heavily on the “exorbitant privilege” this status offers. The dollar is the dominant currency in global trade and international financial markets, and is the most transacted currency in global foreign exchange markets. All told, the continuous foreign demand for dollars is extreme. That demand keeps the dollar relatively strong and typically overwhelms other fundamental considerations that might otherwise hurt non-reserve currencies, such as high debt-to-GDP levels, rapid money supply growth, and twin trade and current account deficits.
As far as the dollar fundamentals go, the extreme global demand for dollars actually incentivizes and structurally requires a US trade deficit. This is happening, and has been happening for decades. The February US trade deficit was a record $71.1 billion. The long-term consequences of trade deficits are wide-ranging and serious, but one of the most important for the future of the dollar is that it has hollowed out the domestic manufacturing base and left the export economy rather uncompetitive.
Reserve currency status and its structural foreign demand for dollars has also facilitated huge amounts of public and private borrowing and deficit spending in the US. Taking excessive advantage of this privilege has led to rising debt-to-GDP levels that now stand at 107%. Debt at these high levels has historically been inflated away with negative real yields.
The US is by no means the only country with a debt-to-GDP problem. It’s really a concerning universal characteristic of our time that supports the likelihood of a broad-based currency devaluation event. What is specifically troubling for the US dollar is that many other countries have trade balances and surpluses acting as a relative fundamental floor to their currency, while the US has no such protection from it’s hollowed-out manufacturing base. Both the debt and structural trade deficit both negatively impact dollar fundaments and threaten dollar strength and stability going forward.
Over time, significant issues are emerging that may conspire to compromise the degree of US dollar dominance. Domestically, the damage to the manufacturing base of the US has created a significant burden on labor. The wealth inequality and growing populism rooted in this problem have increasingly become politically untenable. The erosion of the US manufacturing base has also put the US in a vulnerable strategic position, where the country is increasingly unable to source critical goods, materials, and components within the US.
From the international standpoint, the US is losing ground to foreign countries in terms of its share of global GDP. The number of foreign countries for whom the US is the largest trade partner has also decreased dramatically just since the year 2000. This has made it more difficult for the US to easily supply the number of dollars needed by the rest of the world. This dynamic has encouraged other countries to find work-arounds to the dollar system. Perhaps most significantly, China is expected to shift it’s currency regime from one pegged to other currencies to one allowing a much more freely fluctuating exchange rate that can compete against the dollar. That development could trigger the creation of a significant Asian currency block. Currently, the dollar is the currency anchoring the vast majority of global GDP, but a Chinese currency development could cut that almost in half.
Warren Buffet, referring to stocks, says that, “It’s only when the tide goes out that you learn who’s been swimming naked.” The combination of poor fundamentals and any erosion of reserve currency status could reveal a naked US dollar. Given these risks, any accelerated decline in the dollar index from here is likely to increasingly bring attention to some of these dollar vulnerabilities and similarly draw attention to aspects of the hard-asset thesis.
As for weekly performance, in the precious metals space, the yellow metal was up 2.03%, silver was up 3.08%, platinum was down 0.05%, while palladium was the standout, up 5.21%. The HUI Gold Miners Index was up 3.17%. IFRA, the I Shares US Infrastructure ETF, was up 2.03%.
Energy commodities had a big week. Oil surged 6.52%, while natural gas prices gained 5.93%. Oil services stocks (OIH), didn’t play along, dropping 0.57% on the week. The CRB Commodity Index was up 3.46%. The Dow Jones US Real Estate index ended the week up 2.47%, while the Dow Jones Utilities was up 3.59%. The US Dollar Index lost ground on the week, down 0.69%. The yield on the 10-year Treasury was down 8 bps.
Have a great weekend!
Chief Executive Officer