The Global Dollar Short Squeeze
In recent decades, the S&P 500 now receives over 40% of its revenue from international sources, and a stronger dollar means that when those foreign revenues are translated back into dollars, it comes out to a lower number of dollars. The percentage of S&P 500 sales from foreign sources peaked in 2014 and has been on a mild downtrend, coinciding
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These trade deficits are self-reinforcing rather than planned. It’s not like the global reserve country necessarily decides to have persistent trade deficits. Using the United States as an example, if the whole world agrees or is forced to mainly use dollars to buy commodities and settle the majority of international deals, then there is naturally
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Why Each Time is Worse
Each of these three dollar spikes over the past five decades caused harm to the global financial system at a lower level of dollar strength than the previous spike, resulting in either a planned correction or a self-correction towards a weaker dollar. There are likely two main reasons for this.
Firstly, global trade accounted
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The U.S. housing and banking system was the epicenter of the global financial crisis in 2008, and the Fed used a few rounds of quantitative easing (i.e. expanding the monetary base to buy U.S. government debt and other securities) in the aftermath, which kept its currency relatively weak due to plentiful supply.
When the United States finished its
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Imagine, as an extreme example, that the entire world had to use Swiss francs for its international transactions and commodity purchases. It simply wouldn’t work, because there isn’t enough money supply from that small country for the whole world to use. It’s not liquid enough; there aren’t enough francs.
The current system is running into that
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Emerging markets as we currently know them didn’t exist during the 1980’s dollar spike. The MSCI Emerging Market Index was created shortly afterward in 1987, and it was a small share of global GDP at the time. Developing countries of course existed during this dollar spike, but just weren’t significant players in the dollar market. So, this 1980’s
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In other words, while there is significant foreign demand for dollars (especially to service the aforementioned dollar-denominated debts), there is not a big foreign demand for Treasuries. That’s a key distinction, and that’s what generally happens when the dollar is strong. When the dollar starts rising into a spike, foreigners hold less and less
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The first and largest dollar spike occurred in the mid-1980’s. From the 1970’s and into the early 1980’s, the U.S. dollar encountered serious devaluation and inflation, so Fed Chairman Paul Volcker hiked interest rates up to the double digits to stabilize the dollar and force inflation back down. This, however, made the real interest rate on the
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The orange line could occur if a lot of private European and Japanese investors buy un-hedged Treasuries in a risk-off move, which would delay the need for increased U.S. debt monetization by the Federal Reserve. Either way, I expect down for the dollar in the multi-year long run, but the path to get there has these two main outcomes, in my view.
Th
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If many private investors from Europe and Japan decide to buy U.S. government bonds without any protection against losses, it could slow down the need for the Federal Reserve to create more money to cover U.S. debt. In the long run, I believe the value of the dollar will go down, but there are two main ways this could happen.
To understand when and if the dollar might suddenly increase in value, we should pay attention to the Federal Reserve's financial situation and how much these foreign investors are buying. If they buy a lot of U.S. bonds, it could delay the Fed needing to create more money to handle the growing U.S. government debt. However, if not enough people want to buy these bonds to cover more than $1 trillion in yearly U.S. government spending, the Fed will have to step in and create a lot of money to fill that gap, which could add a lot of dollars into the economy for years to come.