Is the U.S. economy safe? That question has been posed quite often lately among our community of sensible investors. The fear of increasing tariffs is looming, causing investors to question whether their money is safe in a hyperinflation scenario. What happens if the dollar weakens? What will happen to the stock market? How can you protect your portfolio from inflation? We’ll explore these questions and more.
What happens if the US dollar completely implodes? Half our audience hails from America and this question keeps coming up more and more. That’s because when you start tinkering with the world’s most sophisticated economic system, bad things can happen. If the US dollar collapses, will your wealth collapse alongside of it? What does a weak dollar mean for your portfolio? Let’s start answering these questions with a look at how we measure the strength of the US dollar.
So I’ve spent most my life outside the United States and in the past six months I’ve used at least 10 currencies. I always carry a single $100 bill in my passport holder right here because that’s a decent bribe in most places and nearly all places you can get a couple nights lodging in a few meals for that. Now the amount of any currency I can buy with that $100 varies based on exchange rates. So for example in Pakistan recently when I couldn’t find a working ATM, I traded that $100 bill for 27,000 Pakistani Rupees.
You can see a Pakistani note right here this is 10 rupees, it’s worth about 3 cents. So since the exchange rate was 280 Pakistan rupees for $1 US, I should have received 28,000, I received 27,000 because the seller wanted a commission on that exchange. Then going forward, I just divided all the prices I came across by 300 and it was easygoing. This becomes second nature when you travel a lot, to start thinking in different currencies.
Let’s say that the US dollar suddenly became worth 300 Pakistan Rupees, does that mean the US dollar strengthened or did the Rupee weaken? And what happens if both the US dollar and the Pakistani Rupee strengthen at the same time or even weaken at the same time? Now you’re beginning to see the problem that you have using a single currency pair.
So when we want to measure the strength of the US dollar, what we need is a basket of currencies. And perhaps the oldest basket is referred to as the US Dollar Index. You can see here the various weightings. They’re actually fixed.
This is meant to represent the US’ most significant trading partners. We covered this in a piece, oh about 3 years ago, when people were asking these same questions about the US dollar collapsing. And what astute observers will quickly point out is that this doesn’t really reflect the US’ biggest current trading partners. And you can see here, this is from a piece we recently did on tariffs.
It looks at how China, Mexico, and Canada make up 44% of US imports. Also on the export side, this weighting is largely mimicked. What we can then do is use the nominal broad US Dollar Index. So this is a measure of the value of the dollar against a broad basket of foreign currencies that is weighted according to their current importance in US trade.
So this trade-weighted index is quite an improvement and it incorporates more currencies and yearly rebalancing. So it’s a more accurate reflection of the strength of the US dollar. So the takeaways really are this.
The US dollar is going to strengthen and weaken all the time. There are various ways to measure this. You can see along the bottom, there are a number of other measures that are used.
The dollar right now is at current high levels. It’s been persistently strong but the behavior of the US dollar isn’t very intuitive and one example of that would be the dollar smile.
So if the US economy is doing really poorly, as you know, when the US sneezes, the world catches a cold. So that means everybody’s worried in the global economy and they have a flight to safety to the US dollar. So when the US economy does poorly there’s actually a flight to safety to the US dollar. So it helps strengthen the US dollar. Conversely, when the US economy is running very strong then, of course, the US dollar strengthens as well. So that’s the smile you see there and then somewhere in the middle is where we see the strength of the US dollar decline.
Now when the US dollar strengthens, that’s good for America because we can buy goods that we import, because we import more than we export, we can buy those goods cheaper. However, when it weakens and this, of course, is the persistent concern everyone has. That means our goods and services become cheaper so that’s good for exports. But then, when we go to buy because as I said we import more than we export that’s a problem. And here you can see the deficit between imports and exports, this so-called trade balance that is increasing over time.
So, intuitively, a weaker dollar should harm more than help. And when we look at the impacts of a weak dollar, again, as measured against this basket of currencies, goods imported to the US like electronics, oil, consumer products – these become more expensive driving prices up so you have inflation.
Now US goods are cheaper, that’s somewhat offsetting the inflation effect. However, if domestic production can’t meet that demand or if that production relies on imported inputs that have also gone up, then this benefit may be limited. Now to combat inflation, the Federal Reserve, of course, can raise interest rates. Higher rates could slow economic growth, raise mortgage and credit card payments leading to a recession.
Now lowering interest rates when inflation is increasing, that’s a concern that you see perhaps voiced today. The current administration chooses to do that. That will typically exacerbate inflation. So it’s not a good thing to do. Now foreign investors, when the US dollar weakens, also might reduce their purchases of US Treasury bonds pushing up yields and increasing the cost of government borrowing. So that’s a problem.
The bigger picture would be that if confidence in the dollar erodes significantly, then this could jeopardize the dollar’s role as the global reserve currency.
The reason that the dollar is the global reserve currency and why I carry a reserve of it in my passport holder is because it’s accepted globally for transactions, it’s considered stable and reliable, it’s easily convertible, and available in volumes, it’s backed by a strong and stable economy, at least, for the moment.
So around 58% of global reserves are in US Dollar, 20% in Euro, and around 2 to 3% in Yuan, Chinese currency. So when the dollar weakens, this reduces the demand for dollars and it limits the US’ ability to run large deficits and, of course, diminishes its geopolitical influence.
So a weak US dollar seems to increase systemic risk and that’s what everybody seems to be worried about. Now those with assets tied to foreign currencies or commodities could benefit from the weakening dollar while wage earners and savers lose out. So the outcome of a weak dollar will not be predictable and will likely be counterintuitive.
So I came across this piece from MSCI, this is a firm I worked with for over a decade, this is a scenario analysis.
So we had really cool tools that would let you run certain scenarios with particular parameters so you could gauge the impact of a particular event across various asset classes. Now one of the gentlemen putting this together, Mr. Thomas Verbraken, a friend of mine. I remember when I first interviewed him, I went right down to the bottom of his CV and started talking about his time off that he took traveling. So if you’re somebody that’s looking to make your CV stand out, I always put something down at the bottom that sort of draws the interviewer’s eye, right, because that makes you stand out. So he did an excellent job on this piece which looks at a what-if scenario.
What if we had an inflationary spike, so we can see that happening with tariffs, right; a drag on growth that’s based on our tariff video, that’s what we expect to happen; and strength in the US dollar. So what if we saw all three of those things? Well, in this scenario, the value of a diversified portfolio of global equities and US bonds would decline by almost 15%. So there’s no place that you can go to for safety.
So you read something like this, you say, are you still worried about the dollar weakening? Maybe what you’re really worried about and what I see people mention is this notion of hyperinflation. Now before we get into that, a public service announcement.
I’ve spent most my life living outside the United States. I’ve worked for multinational firms on three continents and traveled to nearly 150 countries. In all the time I spent studying global economies, the most common conclusion I reached was this – the study of economics is not just dreadfully boring, it’s pointless. You know what happens when you put 10 economists in a room? You get 11 opinions. Economic forecasters seem to assume everything except responsibility and they’ve successfully predicted 10 out of the last five recessions.
Point is, you need to have a consistent strategy that you apply regardless of whatever is happening in the market or whatever the forecasters are saying is going to happen. So what most people are afraid about is a black swan, like hyperinflation, and this starts to delve into economics quite a bit. And you have some examples listed out here.
I think most often, people will point to Argentina and Zimbabwe as examples of what can go wrong. So hyperinflation scenarios for the United States. How would we ever end up going down that path? Well, you could have massive uncontrolled money printing and it would be well beyond the scale of what you see now. So if the Federal Reserve were to print money at an unprecedented scale, for example, if M2 money supply grew by 50 to 100% annually without corresponding GDP growth, then inflation could spiral.
Here you can see how the M2 money supply actually spiked there during COVID quite a bit but then it came back down. So that’s a metric that you can watch for the uncontrolled money printing scenario.
You could have the loss of the dollar as a reserve status so if global confidence in the dollar wanes, say, due to geopolitical shifts or coordinated moves by major economies, that could prove to be problematic. Severe supply shock.
So a catastrophic disruption to US production, perhaps a prolonged energy crisis, widespread natural disasters, or a global trade collapse right, debt default, or fiscal collapse that the US government with 33 or, what, $36 trillion in debt now faces a crisis where it can’t borrow anymore. What would likely happen to trigger hyperinflation is a combination of these various events. It often requires multiple failures.
Now factors that are preventing this black swan from happening. So you have the independent Federal Reserve. So the Fed’s mandate to maintain price stability and employment allows it to adjust monetary policy and you start getting into economics there.
Strong institutional framework. The US has robust economic institutions, a stable banking system, transparent markets, and legal protections, global demand for the dollar as a reserve currency, the US dollars in high demand, you have economic diversification, the US is quite large diverse and resilient, and fiscal and monetary coordination. The US can historically balance their deficits and money creation with policy adjustments.
Now to protect against hyperinflation. So that’s what everybody wants to know, right? If this black swan happens, how do I protect against it? Well, the usual suspects – we have gold and precious metals.
Gold, historically, has held value during inflationary periods. I suggest you watch our recent piece on gold and it describes why you ought to hold gold. It’s not speculating on the price of a commodity. It’s because it provides a valuable diversification effect for your portfolio. Real estate property tends to appreciate with inflation. You have commodities that are often a hedge against inflation. Companies with strong pricing power. So consumer staples, healthcare, utilities, cash loses value very rapidly in hyperinflation so you’d want to have your cash put to work. We’re doing a piece soon, if we haven’t already, on how to put cash to work in the markets and why you may not want at all to time the markets.
Now US investors can look at what’s called TIPS and series I savings, bonds. So TIPS are Treasury Inflation Protected Securities. So they’re type of treasury security issued by the US government.
There’s ETFs you can use to get access to these but you could just buy them directly from the US government instead of paying an ETF provider some basis points there. They’re indexed to inflation to protect investors from a decline in the purchasing power of their money. And what I think is more interesting perhaps are these Series I Savings Bonds.
Whenever the government puts a limit on something, that should make you want to avail yourself of that because that limit’s there for a reason. This sort of vehicle is probably quite helpful for investors, that’s why the limit exists. Now these savings bonds, they’re quite interesting. I took a look into them. They have this fixed rate which adjusts and every 6 months, they’ll reset the fixed rate and reset this inflation rate that’s added to the fixed rate to determine the interest that the bond generates.
If you want to know more about TIPS or Series I bonds, I found the latter to be quite interesting, then please let us know. Premium subscribers, you can raise this on Discord and that will get our attention immediately and we’ll perhaps look to cover these instruments.
Now when it comes to where most of our money has been allocated, it’s in multinational dividend growth stocks and these seem to have a natural hedge against the weakening US dollar. So companies earning revenue in stronger foreign currencies benefit when they convert those earnings back to US dollars. Multinationals with significant US operations can ramp up production or marketing in various jurisdictions to capitalize on whatever is happening with the dollar.
And many multinationals use currency hedging to mitigate exchange rate volatility. Now we find it’s highly desirable for firms to have geographically diversified revenue streams and it’s why our quantigence strategy, which we use to identify the most promising dividend growth firms, it’s why it rewards firms with strong international operations.
So takeaways here. The US dollar is currently quite strong and will likely remain strong because of the dollar smile. That’s what the economists say will happen. Now the weakening US dollar is going to likely create inflation and there are ways to manage that in your own portfolio and the dread that most investors seem to have manifests itself around a hyperinflation scenario which is, of course, a black swan for reasons that we talked about.
Should that ever happen, there ought to be clear signs of what’s coming and, of course, that flight to safety would then be unprecedented and it would be difficult to predict what would happen. As we’ve been saying, these things will never be predictable or defensible. It’s sort of the nature of the beast. You should stay the course with your strategy and always make sure you’re diversified across asset classes and that should include holding some alternatives.
Now if you’re terrified about the tariffs, then you ought to watch this piece we did that looks at that. It relates a lot to some of the things that we’ve talked about today. Give that a watch next. Thanks so much for taking the time to watch this video today.
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Sadly, although you give some good advice, you apparently believe that dollars grow on billionaires, and a monetary sovereign (like the US) must borrow the money it creates literally without limit.
You also point to “over-printing” money as a potential cause of inflation. The Cato Institute–a Koch-funded, libertarian think tanks–published a study of 56 historical hyperinflations. How many began with a central bank run amok, issuing too much currency? Answer: zero. Typically such events occur when there’s a supply shock and a balance of payments issue, not with too much money.
Nanalyze Weekly includes useful insights written by our team of underpaid MBAs, research on new disruptive technology stocks flying under the radar, and summaries of our recent research. Always 100% free.
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