Hedging the Coming US Dollar Depreciation

Economics, Premium POM18 Comments

Strategies for Central Banks & the Average American

By JC Collins

The terms depreciation and devaluation are often used in an interchangeable context.  Though this is not always a big issue, as the intent for the average layperson is clear, it is worthwhile to take a moment to clarify the terms and ensure we understand the difference.

Depreciation is brought about when there is a change in the supply and demand side of a currency’s exchange.  When there is less demand for a currency, that currency will depreciate in value, like any other asset.

In turn, when the demand for a currency increases, the value of that currency will also increase.  A suitable example of this process is the global demand for US dollar denominated assets in the foreign exchange reserve accounts of the world’s central banks.

Such demand pressures placed on the USD from holding the title of the international reserve currency has caused the dollar to appreciate.  This appreciation has led to domestic challenges for America, especially in the form of decreasing exports and job losses, as American made goods become too expensive for the rest of the world.

Devaluation is brought about when the exchange rate of a currency is adjusted to decrease the valuation of that currency against other currencies or assets.  Such an example can be found in China’s recent moves on lowering the daily fixed rate of the yuan against the dollar.

So which one of these scenarios will apply to the US dollar?  Depreciation?  Or devaluation?

On one hand, the amount of dollars in the foreign exchange reserve accounts must decrease in order for the US to begin adjusting the exchange rate pairings.  No one wants to take the losses on this devaluation. But this decrease in reserves is also tantamount to a decrease in demand, as the rest of the world recognizes the need to diversify out of dollar denominated reserves and find a more balanced framework within a multilateral approach.

Such a multilateral approach will be initially realized by a mix of reserves that will be more balanced between the dollar, euro, and yuan.  In the years to come we will see this reserve diversification take on the face of a true multilateral asset, such as represented by the SDR of the International Monetary Fund.

Until such a time we will live in a world of competing reserve currencies.  Not necessarily such a bad thing.

The diversifying of dollar denominated reserves is in affect a lowering of demand for dollar denominated assets.  In such a scenario the dollar would be faced with depreciation as opposed to devaluation.

Yet, it is necessary for the dollar’s exchange rate regime to change to reflect the realities of the emerging economies, and meet the domestic demand, and expectations, of increased exports and job growth.

I have chosen to use the term depreciation in the title of this post because the accumulation of dollar denominated assets in the foreign exchange reserve accounts is the primary and fundamental challenge which the international financial system has faced now for many decades.  This amounts to a decrease in demand for dollar denominated assets.  Whether through planning or accident, the decrease in demand is coming.

So how do countries, and central banks, protect themselves against this coming depreciation of the dollar?  How do average Americans?

Let’s use the People’s Bank of China as an example.  They hold over a trillion dollars’ worth of USD denominated assets.  In the post Potential Path Forward on Fed Rate Increases – Sovereign Wealth Funds, Reserve Diversification, and Capital Flows, we reviewed how China could transfer their dollar denominated assets into their sovereign wealth fund.  The SWF could than invest those funds into the equities markets.

Let’s take that logic further and consider the possibility that China’s SWF, called China Investment Corporation, could invest those funds into American equity markets, and American factories, corporations, mines, etc.

This would in affect amount to a hedge on losses when the dollar depreciates.  As stated above, a dollar depreciation will increase US exports, which means factories fire back up, domestic job growth increases, and the economy as a whole expands.

Any sovereign wealth fund which invests into America will see a return on that investment which will offset any losses which are realized through a dollar depreciation.  This is the perfect hedging strategy for central banks which hold dollar denominated reserves.

They could as well also invest those funds into other markets and commodities, including infrastructure development in the emerging economies.  Commodities, which are now at record lows, will rebound and begin to increase on the momentum of large infrastructure development projects in emerging regions.

The average citizen can also use the same strategy as investing in commodities, mining, and American companies which will capitalize on the depreciation of the dollar, and said increase in production and exporting capacity.

This is just the broad strokes on a strategy which will be more clearly defined in the coming months, and into next year.  The ability for Americans to re-invest back into themselves, and their own country, is wonderful in that real growth and sustainability can be achieved at the regional level.

As I’ve stated in previous posts, countries with large trade surpluses will have their currency appreciate in order to facilitate the decrease in exports and required adjustments to the surplus.  Countries with large trade deficits, like the US, will have their currency depreciate in order to facilitate the increase in exports and required adjustments to the deficit.

The issue with the dollar is that this process is somewhat more challenging as it is the reserve currency and large amounts of it has accumulated in the foreign exchange reserves.  This challenge has been addressed in this post, and in previous posts.

As such, keen investors can hold the currency of those countries with large trade surpluses, or assets denominated in those currencies, in the anticipation that an increase in valuation will ensue in the months and years during the transition process.  Hedge the coming dollar losses.  - JC

18 Comments on “Hedging the Coming US Dollar Depreciation”

  1. Here is evidence that Qatar is moving to invest Sovereign Wealth funds in the US:

    Qatar’ sovereign wealth fund plans to open an office in New York and invest $35 billion in the United States over the next five years. The new office will give the fund better access to investment partners and help diversify assets, the Qatar Investment Authority said. The QIA's existing American holdings include more than 10 percent of New York-based luxury jeweler Tiffany & Co. Qatar, an important ally of the US in the Arab world, hosts American bombers, support aircraft and the forward headquarters for US Central Command.

  2. JC,

    Do you see this move towards a more stable multilateral financial system having a positive effect on the distribution of wealth in the US – positive meaning a more equitable system that leaves room for a substantial middle class? I am wondering who is most likely to receive the spoils of this new American Renaissance and the jobs that come with it. Your analysis can remain true with high levels of labor exploitation and wage theft, as they are not mutually exclusive. Thank you for the post.

  3. Question:
    When all those USD reserves get dumped where do they actually go ? If they find their way into the economy won't that create a flood of USD in circulation thus setting off hyperinflation (Devaluation) ?

    1. I support a repeal of the 16th Amendment to the USC.

      Oh, wait! I forgot. That supposed amendment never had the support of enough States to become Law.

    1. I see his point and you're most likely right. But I still don’t see how Trump can claim to be able to bring this money back to the US outside of some sort of global taxation structure.

      Can you see how he can claim the prize or bring it back to the US?

      Don’t get me wrong I don’t think it’s all about taxes. The US has tons of regulation for manufacturing which I feel has pushed many companies outside of the US. These regulations drive up the cost of doing business in the US.

      Maybe this is where the devaluing USD along with the rising values of developing nations will balance out the cost in order for the US to begin exporting again?

      1. Dane here is a decent article on the Trump tax plan. What Trump is talking about is repatriation and there are mixed feelings on this. There are those that feel that this has been done before and didn't work,but some say that it could be done effectively if the loopholes are closed. Many corporations find loopholes that allow them to bring the money back into the states without paying high taxes..so as always...fixing it so their won't be those loopholes will be the difficult part. Jeb Bush has a similar plan as well. I just haven't looked to see how the two differ yet. At least that is in regards to repatriation for corporations. Honestly Idk..as I am not that learned on how well repatriation would work, so I think JC would be much better at this than myself, but at least I now know what Trump is talking about as far as bringing money back into the country. I think he will probably hone these ideas some once he gets together with other economists and Icahn..who has now endorsed him.

        Here is the article on the tax plan and it isn't the best, but I will look for another one that is a bit better.

          1. I am still a little confused as to what happens after the one time repatriation fee of 10 percent..is there nothing after that or what.. ?? The 2.5 trillion dollars is cash held overseas.

            A one-time deemed repatriation of corporate cash held overseas at a significantly discounted 10% tax rate. Since we are making America’s corporate tax rate globally competitive, it is only fair that corporations help make that move fiscally responsible. U.S.-owned corporations have as much as $2.5 trillion in cash sitting overseas. Some companies have been leaving cash overseas as a tax maneuver. Under this plan, they can bring their cash home and put it to work in America while benefitting from the newly-lowered corporate tax rate that is globally competitive and no longer requires parking cash overseas. Other companies have cash overseas for specific business units or activities. They can leave that cash overseas, but they will still have to pay the one-time repatriation fee.

        1. Hello Dottie thanks for the links. I will read them in a bit. One thing that came to my mind last night while reflecting on the video was this.

          When I buy something from http://www.whoever.com and its an overseas purchase I don't pay tax. When I get the package its postage paid and comes through customs but I wonder who pays the import tariff?

          So this money is sitting outside of the US and can't come back in unless they pay taxes or tariff?

          You see the UN is working on this issue already....

          "1. Raise sufficient public resources to finance high quality essential services for all
          Current target 15 (o) on domestic resource mobilization should be retained as a stand-alone national target, but the phrase “reducing tax evasion and avoidance, improving stole asset recovery” should be placed under a separate global target (target 2 below) to emphasize the clear, time-bound commitments of all countries for this global phenomenon, especially those on the receiving end of cross-border tax abuses.

          2. End cross-border tax evasion, return stolen assets, forgive odious debt and progressively combat tax abuses
          Rephrase current target 16(e) this way to highlight the imperative of international cooperation, especially by developed countries, as well as to make the target more policy-sensitive to the most acidic of illicit financial flows.
          Targets to ensure equality in the burdens and benefits of sustainable development financing

          3. Reduce economic inequality within countries, through enhanced use of progressive taxation on income and wealth
          Rephrase either targets 1 (b) and/or FA 8(a) this way. A focus on the bottom 40% of the income bracket is laudable target to fight relative poverty, but will not provide the policy incentives to address economic inequality per se, let alone eradicate the type of extreme inequality we face today."

          and then down in section 6 of this document they drop this "business, taxation".


          1. I will read all this soon Dane. i have been so insanely busy..I don't have time to smell the roses.lol...Repatriation is not connected to any of this though, but like I said I will read this soon.

          2. hahaha. No I actually thought I made up the address. Seems I'm not so creative after all. Maybe "whatever dot com" would have been better. lol. Thats what happens when I don't proof things first. Sorry for the mislead pal.

  4. Well, the US has already passed an international global taxation structure recently, so I wouldn't say it's not possible... just look up FATCA. I also agree that it's not all taxes and could possibly have to do also with the multilateral transition we are witnessing.

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