It has been a roller coaster ride for the U.S. dollar in the first half of 2021.
The U.S. Dollar Index (DXY), a measurement of the greenback against a basket of currencies, kicked off the year defying market expectations. Financial analysts anticipated a bearish beginning for the index, alluding to confidence in the broader financial markets and the global economic recovery thanks to the coronavirus vaccine.
Following several up-and-down months, the DXY is now flat on the year (as of May 18), erasing its three percent gain on the year. But what is happening? There are many factors to explore, from near-zero interest rates and unlimited quantitative easing etched into the market to investors putting their money in riskier foreign currencies. With one-quarter of all U.S. dollars ever created in just one year, can the greenback remain the reserve currency of the world? Will traders retreat to the conventional safe-haven asset during the next financial crisis?
It might depend on how other currencies perform, whether it is the Swiss franc or the euro.
Dollar Dominance Behind Us?
A 2019 Reuters survey polled forex strategists and the conclusion was dollar dominance in 2020. While some survey respondents anticipated a slight rise in other currencies, particularly the euro, the consensus was that the dollar’s dominance was unlikely to diminish last year. And, of course, the coronavirus pandemic happened and everything was in disarray. The greenback became the go-to investment for worried investors trying to protect their assets and avoid the blood in the streets.
So, technically, the poll’s respondents were on the money, with the index gaining about 4% last year.
But the bears were also correct by default. Before the coronavirus pandemic, Commodity Futures Trading Commission (CFTC) data highlighted that speculators had slightly reduced their net long positions in the greenback, suggesting that institutional investors were becoming bears on the dollar. By the summer of last year, it became clear that traders were moving on from the buck on foreign exchange markets. That is until uncertainty began plaguing the markets again.
Jamie Fahy, global macro and asset allocation strategist at Citi, told the newswire:
“We’re not telling investors to go out and buy euros. What we’re telling investors is that the U.S. is converging back to Europe, there are tentative signs across the data set that Europe is stabilizing. Broadly speaking, we’re looking at the big picture theme of U.S. exceptionalism probably reversing.”
But what currency is set to knock the dollar off its pedestal? Nobody is sure. The euro has performed better than many had anticipated. The Swiss franc is holding steady. The Chinese yuan has diminished some of its momentum in recent months. The Canadian dollar has been one of the top-performing currencies
Two fascinating global trends are unfolding: the share of dollars held in global reserves is gradually decreasing and the world is bullish on gold.
According to the International Monetary Fund’s (IMF) Composition of Official Foreign Exchange Reserves (COFER) data for the fourth quarter, shares of U.S. dollars clocked in at 59.02 percent, down from 65.3 percent in the fourth quarter of 2016. Here is where the other currencies stand as of the October-to-December period of 2020:
- Euro: 21.24%
- Japanese yen: 6.03%
- Pound sterling: 4.69%
- Chinese yuan: 2.25%
- Canadian dollar: 2.07%
- Australian dollar: 1.82%
The world is embracing a diverse array of currencies to perhaps broaden their reserves beyond the greenback.
But central banks are not only scooping up more yen and Australian dollars. They are acquiring a lot of gold bullion, too. A new World Gold Council (WGC) report found that central banks were net gold buyers in the first quarter of 2021, increasing their yellow metal holdings by 95.5 tons. The organization is projecting that central banks will be net purchasers for all of 2021.
And not only are central banks making new gold transactions, but they are also repatriating their gold. In recent years, Hungary, Poland, the Netherlands, and many other nations have ordered all or some of their gold holdings to return home from the vaults of the Federal Reserve or the Bank of England (BoE).
With global gold reserves simultaneously ascending with foreign Treasury holdings – at least year-over-year – what will blink first?
Observers have different opinions on the motive behind states going on a metal and repatriation spree.
The most likely explanation is that central banks are attempting to shield themselves from the coming global economic collapse or monetary reset. When it happens is unclear at this point, but policymakers seemingly want to limit their respective nations’ susceptibility to a post-COVID-19 crash, which means de-dollarization and gold-buying full steam ahead.
Because confidence in the fiat currency experiment is being lost, Peter Schiff, president of Euro Pacific Capital, thinks that the world will eventually return to a gold standard:
“The days where the dollar is the reserve currency are numbered and we’re going back to basics. You know, everything old is new again. Gold was money in the past and it will be money again in the future, and central banks that are smart enough to read that writing on the wall are increasing their gold reserves now.”
A gold standard in the 21st century? It might be the only way to rebuild the economic system.
Can the Dollar Survive QE and NIRP?
With so much manipulation occurring inside the Eccles Building and a lot of distortions on Main Street and Wall Street, how is the index still standing at around 90.0? Indeed, the pertinent question to ask is: Is the U.S. dollar surviving because of its strength or because of other currencies’ weaknesses?
The euro may be resuscitated from the dead, the Chinese yuan is trying to crawl from the brink of evisceration, the British pound is entrenched in the unknown amid Brexit, the Swiss franc is under assault, and the Canadian dollar ebbs and flows. The greenback’s purchasing power has eroded since the inception of the Federal Reserve, and there is little reason to think this trend will reverse in the era of QE and NIRP/ZIRP, even once they subside.
Put simply, the dollar can help you weather the light precipitation now, but it will not give you shelter from the tsunami.
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