The Myth of the US Dollar Decline

You may have heard all the buzz, the narratives. USD is on the way out. These narratives create fear and emotion, but they have little value in managing a portfolio. They are also nuanced, so I feel the need to cull out what is real and what distractive noise.

The truth:

1. Fiat currencies are backed by good faith in sovereign governments, not gold like they were a century ago. Their purchasing power is on the continual decline, that much is true. USD is one of them, but one of the best of them.
2. Returns on government spending, in terms of Gross Domestic Product (GDP) created, decline as government debt levels rise relative to real GDP levels.
3. USD holdings of other central banks have declined modestly over time, most recently in terms of an uptick in gold holdings, generally not other fiat currencies.
4. The more powerful emerging countries are trying to divert some of their trade out of the USD settlement currency, particularly on trade that the US is not involved in.

The false narrative about:

1. China can suddenly weaponize its US Treasury holdings by selling them all. While they may like to hurt us, their US holdings stem from their large trade surplus with the US, not because they used to be more friendly. They need these holdings to recycle foreign currency reserves – it naturally hedges their books. To the extent they can divert a sliver of trade out of USD settlement, into CNY or gold, it would allow them to hold slightly less US Treasuries.
2. USD must weaken dramatically – False! Here they fail to tell you what to sell it against. The Dollar Index, or DXY, is often referenced as a benchmark of how strong the USD is to other major currencies. It is an index, so people reference it. Created long ago, it does not adjust for the evolution in markets since it was constructed. Chinese currency (CNY) is not in the index. The Euro (EUR) is over half of the index. Neither of these aspects reflects US trade reality. At best it might be directionally correct in noting when USD is getting stronger or weaker relative to other currencies.

What does it all mean to investors in the US?

A whole lot less than you would think. Hedge the ongoing decline of the USD relative to real assets, not other fiat currencies. We implement this trade within our debasement hedge allocation. Innovation and technology investment has also exceeded loss in USD purchasing power from debasement over longer periods of time.

USD is still the "oil" that makes the global financial machine work. US individuals should not be concerned with a decline in the USD relative to other fiat currencies. USD does not only decline in relation to other currencies. When the markets are calm and fear is low, a gradual weakening of the USD relative to other currencies is healthy and creates market liquidity and supports risk appetite in financial markets.

When markets lack adequate USD liquidity, or ample short-term US T-Bill collateral to allow the financial system to stay as leveraged as it is accustomed to being, the USD strengthens as it is in demand. This sucks market liquidity out of the global financial system and we see noticeable market corrections in stocks and other risky assets. USD (as measured against other currencies) usually strengthens quickly in these risk-off periods.