Dollar Depreciation and Investment Safe Havens
By JC Collins
With so much fear mongering and predetermined analysis surrounding the so-called “demise, or death of the dollar”, it can be frustrating for the average person and investor to step back and reflect on the totality of what the multilateral effects will be on the American currency. What is certain amongst the international financial institutions and central banks is the reduction in reserve currency usage of the dollar.
This reduction will have an effect on the international valuation of the USD and the domestic economic performance of the United States, some of which will be positive and will lead to actual job creation growth.
There are multiple angles from which the macroeconomic analyst can view the transition away from the dollar as the primary reserve currency. The obvious and factual originating point of change comes with the reduction of liquidity in the USD asset market, and the rise of a multilateral source of international liquidity, in this case represented by the SDR of the International Monetary Fund.
This reduction will cause a depreciation of the dollars international value, and it’s from this point where diverging opinions and analysis literally baseline away from each other in opposite directions. One direction promotes the death of the dollar and the collapse of the American economy. As many know, I do not agree with this analysis and find it is based more on mass fear promotion and less on economic fundamentals.
The second direction takes us into the more familiar territory of fact based analysis and the cause and effect of economic fundamentals.
A reduction in both the geopolitical and economic standing of the United States and its currency will initially lead to further weakness in the domestic economy. Some of this weakness has likely been experienced already, but to what extent is difficult to measure. A more sustained depreciation of the dollar will also be caused by this reduction.
This depreciation is not all bad, as it will make American made goods cheaper, leading to an increase in net exports. International investors, most visible in the large amounts of Chinese investors, have anticipated this depreciation and have already made large investments into US infrastructure and production capacity, as explained in the post The New Industrialization of America.
The depreciating dollar will have other broad effects on the overall economic performance of America. Some of these effects will include a decrease in international purchasing power of the dollar, rising commodity prices (this could potentially be offset as I will explain below), and upward pressure on interest rates (which is already visible in the discussions by the Federal Reserve to raise rates).
But most interesting of all the effects of a depreciating dollar will be the reduction of external debt. Whether this reduction of external debt will determine the need for a replacement of the USD as reserve currency with the SDR (as dollars in the foreign reserve accounts around the world will be reduced), or it is the need for a multilateral reserve currency which will dictate the need for a depreciation of the dollar, is somewhat irrelevant as the transition itself is happening regardless.
The international value of the dollar will have the following domestic effects, some can be considered positive while others are considered negative:
- Increase in domestic job creation based on increased production capacity and net exports.
- Inability to continue raising the debt ceiling, which will rise to the surface again this October, the same month as the IMF meeting on the new SDR basket composition.
- Challenges with reducing budget deficits. (things such as military spending will need to be reduced)
- Stabilizing the growth of the federal government’s long-term debt.
The global supply and demand for dollars, as represented in the size of the liquidity of the USD asset market, is directly connected with the buying and selling of USD denominated goods, services, and other financial assets, such as stocks and bonds.
This is where the world could see an increase in commodity prices, as explained above. When the dollar depreciates, we traditionally see an increase in the value of, say oil. This is because oil and other commodities are denominated in dollars. This increase in commodity prices can be offset, or eliminated altogether, by denominating commodities, along with goods, services, and other financial assets, in a multilateral reserve asset, as represented by the SDR.
The need for currency diversification for international investors will also increase with the depreciation of the dollar. With no direct access for retail investors to the SDR, the need for an investment safe haven based on the multilateral framework is not yet available.
Many readers will scold me for not yet producing the ePublication titled Re-Engineering the Dollar. In that publication I will expand further on the concepts and analysis discussed in this piece. Its release has been delayed by a project I’ve been involved in for the purpose of developing an investment safe haven based on the fundamentals of the SDR asset and multilateral framework.
Re-Engineering the Dollar will be released within a few weeks and the special project will be announced here on POM within days. – JC