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The U.S. Dollar Is Losing Its Position As A Reserve Currency

In the past, President Trump has never hidden his disdain for the Fed and its hawkish policies, repeatedly drumming up the fact that the central bank’s interest hike regime was contributing to an overly brawny dollar and a sluggish economy. Trump had even gone as far as asking the White House to explore ways to weaken the currency in a bid to boost exports and spur economic growth. 

The dollar has strengthened for much of the past decade, something that has been blamed for the U.S.’ ballooning deficit.

But now Trump is finally getting what he has always wished for: A weaker dollar, albeit not exactly on his terms.

After hitting a 3-year high on 20th March, the Dollar Index--a measure of the currency’s strength against a basket of six international currencies--has declined nearly 11% in one of its most dramatic slides in years. The greenback has fallen so much that hedge funds have turned bearish against the currency for the first time in years.

Source: Reuters, via The Guardian

Source: Investing.com

According to Bloomberg, last week, net futures and forward positions held by leveraged funds against eight currencies ( not including the dollar), tumbled to -7,881 contracts, essentially meaning that there are more investors betting against the dollar than on it. Indeed, Bloomberg says the shorting spree is partly being driven by bullish bets on the euro, with the european currency having outperformed the dollar by 6% since the beginning of the year.

The euro is currently changing hands at USD 1.194 compared to USD 1.109 on January 1.

Source: XE.com

Stimulus Packages

A key reason why the greenback has been losing momentum can be chalked up to the Fed’s expansionary monetary and fiscal policy as well as its massive Covid-19 relief program. The central bank has undertaken a series of interest rate cuts, with the last one coming in March when it lowered the benchmark rate to 0%-0.25%, marking only the second time that rates were effectively lowered to zero (the first time was during the 2008 financial crisis). 

The Fed also launched a $700B bond-buying program as well as a generous stimulus to shelter the U.S. economy from the ravages of the pandemic. This includes up to $2.3 trillion in lending to support state and local governments, employers, households and financial markets. The combined effect of these measures has been an increasing supply of U.S. dollars hence the gradual devaluation.

To make matters worse, the dollar-buying spree that had propelled the early-March dollar rally shortly after WHO declared Covid-19 a global pandemic has cooled off considerably. With a successful Covid-19 vaccine looking increasingly likely, calm has slowly been returning to the global economy and the equity markets. Consequently, the S&P 500 has managed to pare back all its losses and is now sitting on a 4.5% gain in the year-to-date.

Source: CNN Money

The Gold Trade

It’s not all doom and gloom though.

A weaker dollar is likely to improve the United States’ trade balance by making its exports more competitive. Last year, the IMF said the dollar was overvalued by 6-12% and could have been overvalued by as much as 20% before the slide, so the reset is likely to bring it closer to its true value.

Finally, a weakening dollar has historically been good news to a cross-section of asset classes notably gold, foreign stocks and emerging markets.

Source: Fortune.com

Gold in particular has been on a tear, climbing nearly 30% over the past 12 months to an all-time high of $2,060/oz. 

Source: TradingView

With the dollar weakness expected to extend into the next year, this could be a rare opportunity for gold investors to double down especially on gold stocks which tend to act as a leveraged play on gold by amplifying its moves.

Source: CNN Money

By Alex Kimani for Safehaven.com

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  • Mamdouh Salameh on August 24 2020 said:
    Let us separate the wheat from the chaff. The chaff is a return to the gold standard and the US dollar losing its reserve currency status.

    The once-fringe fantasy of a return to the gold standard is creeping back into the mainstream. Mainstream economists deride it almost without exception. Reintroducing the gold standard would “be a disaster for any large advanced economy,” says the University of Chicago’s Anil Kashyap, who connects enthusiasm for it with “macroeconomic illiteracy.” His colleague, Nobel laureate Richard Thaler, struggles with its very underlying principle: “Why tie to gold?

    In theory, the gold standard limits government spending to only what it can raise in taxes or borrow against its gold reserve, and prevents it from simply printing money to pay its debts. The former Fed chair Alan Greenspan told Congress, “a central bank properly functioning will endeavour to, in many cases, replicate what a gold standard would itself generate.”

    However, the most important argument against the gold standard is that there isn’t physically enough gold around the world to support a reserve currency like the US dollar, the yuan, the euro or the pound starling.

    Still, there are many factors that could undermine the dollar and lead to its devaluation.

    The first factor is that the dollar is overvalued by as much as 20% against a basket of six international currencies according to the International Monetary Fund (IMF). A key reason why the dollar has been losing momentum can be attributed to the Fed’s expansionary monetary and fiscal policy as well as its massive Covid-19 relief programme. The Fed launched a $700-bn bond-buying programme as well as a huge stimulus of up to $2.3 trillion to shelter the U.S. economy from the ravages of the pandemic. The combined effect of these measures has been an increasing supply of U.S. dollars hence the gradual devaluation of the dollar. Moreover, the pandemic and the economic crisis it has triggered caused US GDP to shrink by an estimated 32.9% in the second quarter of 2020 sending US budget deficit soaring to a record 17.9% of GDP.

    The second factor is that US debt spiral cannot go on indefinitely. Outstanding debts are currently estimated at more than $24 trillion and rising. To this may also be added the exposure of the US financial system to trillions of dollars of Treasury bills held by China and many other countries.

    The third factor is the challenge the petro-yuan poses to the petrodollar. The petro-yuan could be a real threat to an already weakened US dollar with the emergence of the yuan as the dominant world currency.

    The petrodollar provides at least three immediate benefits to the United States. It increases global demand for US dollars. It also increases global demand for US debt securities and it gives the United States the ability to buy oil with a currency it can print at will. In geopolitical terms, the petrodollar lends vast economic and political power to the United States. Undermining the petrodollar would undermine the US financial system and the dollar.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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