The United States dollar’s (USD) dominance is significant – 88% of international transactions and the dollar accounting for 58% of global reserves. More recently, BRICS nations – Brazil, Russia, India, China, and South Africa – have contemplated the creation of alternative currencies to challenge the USD’s hegemony. Iraq, Saudi Arabia and the United Arab Emirates are also actively exploring USD alternatives. Russia’s invasion of Ukraine and sanctions imposed upon Russia as a result, including freezing access to $330 billion in USD reserves, have accelerated these efforts and have been making headlines.
Concerns are that with the settlement of commodities (think mostly but not exclusively oil) not being in USD for these countries, this may cause a few different issues for the U.S. These issues include the weakening of the USD; higher commodity prices; and higher interest rates as the de-dollarizers sell their USD reserves. Ultimately, I think this is largely a non-issue for well diversified investors and as boring as it sounds.
One of the most significant risks in introducing a new currency is establishing and maintaining its stability. The USD’s status as a reserve currency is grounded in the economic strength and political stability of the U.S. (Imperfect yes, but proven time and again to be, at worst, the dog with the least fleas.) Its market acceptance also has self-reinforcing effects of widespread adoption.
For BRICS currencies to rival the USD, these nations must demonstrate similar levels of economic resilience and political certainty. While we USD’ers may have just a tad bit of bias, I don’t think it’s unreasonable to be skeptical the BRICS nations can achieve this in short order.
What does history show? The USD’s share of world reserves dropped by about 15% from 2001 through 2022, but 10-year bonds fell over this time. Looking back farther, Pound Sterling was the world’s former reserve currency. From 1940 to 1960 Sterling had a -34% decrease in global currency reserves. Over this time 10-year bond yields increased by 2.8% — hardly off the charts – while growth in the UK’s real GDP was a cumulative 67%.
The USD has been predicted to go in a stage of decline ever since it came off the gold standard and that just hasn’t happened. A recent example: Stephen Roach, a senior fellow at Yale University and the former chairman of Morgan Stanley Asia (no slouch on credentials and credibility), predicted “Dollar Will Plunge 35%, Lose Status As World Reserve Currency.” He warned that the decline of the U.S. dollar could happen at ”warp speed” in the era of coronavirus. To Roach’s credit, unlike many who make bad predictions, he acknowledged his massive miss two years later in a June 27, 2022, article in Project Syndicate. Yes, he still says it’s coming in his mea culpa, but timing matters when making investment decisions.
Within a well-diversified portfolio, there are several assets that would likely respond favorably if these risks were to manifest either over time or abruptly.
While longer-duration bonds would suffer if risks manifest, short-term Treasuries (T-bills or short-term inflation-protected securities) would respond well. Due to their short-term nature, they quickly increase yields as rates climb. Today short-term Treasuries are yielding comfortably north of 5%, providing significant cashflow to shoulder any storm.
Floating-rate debt – known by various names and varieties: senior loans, bank loans, private credit – today has yields several percentage points above short-term Treasuries as compensation for increased credit risk. As rates increased rapidly in 2022, these strategies were relative bright spots for portfolios.
Systematic trend-following strategies would likely profit from the price trends of higher rates and commodities, just as they did in 2022. Even real estate has some merit over time in protecting against inflation.
Domestic stocks may respond in a more mixed fashion, largely depending on the rate of change of these risks manifesting. Yet, markets today are more global and the S&P 500 has been found to have a weak-dollar bias. Foreign stocks would likely benefit from a weakening USD.
You could invest in commodity index futures or previous metals, but these are, at best, difficult asset classes to own. Take two of the largest ETFs here: iShares Commodity Index (GSG) and SPDR Gold Shares (GLD). From January 2013 through July 2023, they returned an annualized -1.4% and +2.2%, respectively, while having volatility greater than broad stock markets. In 2022, GLD was down -0.8%, during this time of high unexpected inflation and rapidly increasing rates. No bueno.
When you hear any prediction that evokes fear of missing out (FOMO) or fear of staying in (FOSI), it is important to not to over-react. A thoughtful investment strategy built upon evidence, process, and diversification will help keep you on track.
Kevin Kroskey, CFP®, MBA | September 2023
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