The Global Dollar Short Squeeze
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.
The Triffin Dilemma Unfolds
In the 1960’s, economist Robert Triffin noted that global reserve currencies have to run large persistent trade deficits, which has been coined the Triffin Dilemma. If the reserve country doesn’t supply the world with a lot of their currency, then the world simply can’t use that currency for international trade, commodity
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And it continues to grow; the United States is running large deficits (5% of GDP) during a period of low unemployment for the first time since the Vietnam War. In other words, we now have significant structural government budget deficits rather than just temporary cyclical/recession deficits:
Lyn Alden • The Global Dollar Short Squeeze
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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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 f
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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, coinci
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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 issu
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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 t
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The strength or weakness of the U.S. dollar is very important for global growth, including S&P 500 earnings growth. A stronger dollar generally impedes growth, while a weaker dollar boosts it.