The dollar has been extremely strong over the past two years. Yet, this persistent dollar strength has been a mystery to many investors, all patiently waiting for the stock market crash. After all, the dollar’s problems are well known.
Year after year, the U.S. continues to report deficits in the trillions. The prevailing economic philosophy in Washington seems to align with Modern Monetary Theory, which means that the U.S. can sustain unlimited deficits and debt, thanks to its ability to print money endlessly to fund these deficits.
Meanwhile, the cost of debt service has doubled in the past 19 months as interest rates have risen. According to Bloomberg data, the interest on the U.S. national debt is projected to exceed $1 trillion annually as interest rates climb.
The ratio of government debt to GDP for the U.S. is at a record high approaching 130% (30% is considered prudent, and anything over 90% is a headwind to any economic growth at all).
The political dysfunction is at its peak. The U.S. is facing a presidential election next year in which one candidate, Biden, is senile and the other candidate, Trump, may be behind bars on Election Day.
So now that these problems are clear in your head, how can the dollar be so strong against such a cheerless and dull landscape? What explains this paradox?
There are two answers to this question:
Answer #1
The first is that yes, while the dollar has its own set of problems, other major currencies face even graver issues and are in much worse shape.
For example, the Chinese yuan is on the brink of collapse, artificially kept alive by temporary measures from Chinese banks.
The Japanese yen, closely tied to the yuan due to Japan’s significant investments in China, financed by Japanese banks, faces similar risks. With the yuan going down, the yen will go down in sync.
So that’s two major currencies with problems.
Meanwhile, Europe and the U.K., having deindustrialized by embracing environmentally-focused economic policies, under the sway of the greeniacs pushing the Green New Scam policies, now face potential energy crises and economic downturns. Europe faces a winter of freezing in the dark if cold weather is extreme and Russia decides to turn off the energy taps.
Germany, the largest economy in the eurozone, is heading for recession if it isn’t already in one, and the same is true for the U.K.
That’s two more major currencies facing troubles.
So yes, the dollar has its problems, but as an investor do you really prefer sterling, euros, yen or yuan?
Answer #2
The second reason for the strength of the dollar is a lot more technical and not well understood by most, yet critical to grasp. You don’t need to nail down the technicals, it’s enough that you get the bigger picture.
It involves the so-called Eurodollar market and its dynamics.
Eurodollars are dollar-denominated deposits held at foreign banks. They are therefore outside the jurisdiction of the Fed and U.S. banking regulations. Although they’re called Eurodollars, the banks where they’re deposited can be anywhere in the world. It’s a global system. The eurodollar market is actually one of the world’s major capital markets.
The Fed has very little influence or control over the global dollar market and the exchange value of the dollar.
This market is a key global capital market, with major banks in cities like London, New York, and Tokyo playing pivotal roles. It’s here where global liquidity and interest rates are actually determined.
The Eurodollar market needs a constant supply of depositors parking their money in foreign banks, in particular to support derivatives positions. These banks face a liquidity challenge if deposits drop.
As I write this, the Eurodollar market is in contraction.
Financial derivatives are being settled, balance sheets are being trimmed and interbank overnight lending is being financed with collateral.
And of course these banks are demanding the best collateral. They won’t accept corporate debt, mortgages or even intermediate-term U.S. Treasuries. The only acceptable collateral consists of short-term U.S. Treasury bills, the shorter the better. This means 1-month, 3-month and 6-month bills.
Those are denominated in dollars, obviously. So in order to get the bills to post as collateral, banks have to buy dollars to buy the bills. This has created huge demand for dollars. And that partly accounts for the strength of the dollar.
Again, it’s not important that you understand the details of the eurodollar system, just that high dollar demand in the Eurodollar market is contributing to dollar strength.
The fundamental dollar shortage problem is not going away soon, and will continue to support the dollar.
What About the New BRICS Currency?
What about the prospect of a BRICS currency union and the move toward a new currency? I wrote about that ahead of the BRICS Leadership Summit that took place back in August.
As mentioned, this new currency would be gold-linked and would replace the dollar in time as a major player in world trade.
Shouldn’t that be weakening the dollar?
After all, the prospect of a new BRICS currency should pose a severe threat to the petrodollar, which is a pillar of dollar strength.
But this movement is still in its early stages and, unsurprisingly, is experiencing growing pains due to a lack of cohesion between the BRICS countries. In fact, one of those BRICS nations — India — seems to be playing both sides.
It was recently reported that India’s government is expected to reject demands from Russian oil companies to pay for Russia’s crude oil imports in Chinese yuan.
Russia currently has a surplus of rupees and has limited ways of spending them. At the same time, demand for yuan has grown as Russia trades increase with China.
Meanwhile, India mostly uses the dirham and U.S. dollar to pay for Russian oil imports. Basically, India considers Russia an important economic ally while they consider China a geopolitical rival.
India is concerned that promoting the yuan might undermine its attempts to gain global acceptance for the rupee. Indeed, India stood alone among the BRICS countries in resisting the proposal of a shared currency, worried that it might advantage the yuan.
India's decision not to yield to Russian requests ensures the dollar maintains a crucial role, reinforcing the expectation that the dollar will continue to be strong in the coming years.
The Golden Ruler
Now, to be clear, I'm not suggesting that the dollar is strong. It isn’t, given the various issues I've outlined earlier. However, it appears strong because it is relatively more robust than its rival currencies.
Is there some way to tell if the dollar is actually getting stronger or weaker without making reference to other currencies?
Yes. The answer is gold. Consider gold as a benchmark for assessing the strength or weakness of the dollar.
Recently, gold's value has risen by nearly 10%. We expect gold will continue to increase in value, despite potential short-term fluctuations.
For investors, the current market prices present a unique opportunity, possibly the last of its kind, to invest in gold before a significant surge in demand for this safe-haven asset commences.
With its price currently under $2,000, gold is remarkably undervalued, making it an incredibly attractive investment. I strongly urge you to take advantage.
Stay alert, stay informed.
Wave Cap
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