by Bryan Perry
January 3, 2024
It is widely understood that the U.S. dollar is still the world’s reserve currency, primarily because of its stability and acceptance in international trade. Ever since the 1944 Bretton Woods Agreement formalized the U.S. dollar’s status as the world’s reserve currency, backed by the largest gold reserves, the dollar has remained King, although it was officially de-pegged from gold on August 15, 1971, by President Nixon in a series of economic measures known as the Nixon Shock. The dollar then suffered during the 1970s versus the German mark, Swiss franc, Japanese yen and other currencies, until reviving strongly in the early ‘80s.
Nixon’s 1971 gold de-pegging was done in response to rising inflation and a soaring trade deficit, which made it increasingly difficult to maintain the gold exchange standard. From that time to today, the dollar trades as a “fiat” currency, meaning that its value is not backed by any physical commodity, but instead trades on the full faith and credit of the U.S. Treasury. It has continued to hold the mantle as the world’s reserve currency based on trust, being backed by the world’s #1 economy and dominant military power.
Several other countries have sought stability in their sovereign currencies by pegging their exchange rates to the dollar, with much of the global financial system dependent on the stability of the dollar for the smooth free flow of international trade. For instance, most crude oil transactions today are denominated in U.S. dollars, despite efforts by China to undermine the dollar standard in global oil trading.
After the United States abandoned the gold standard, the U.S. dollar index (DXY) was established in 1973 as a measure of the value of the U.S. dollar relative to a basket of foreign currencies. After the euro took over the previous role of the German mark, French franc, Italian lira, Spanish peso and other eurozone currencies in 1999, the euro became the largest component of the U.S. Dollar index, making up 57.6% of the basket. The weights of the rest of the currencies in the index are, in order, the Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%) and Swiss franc (3.6%).
The history of the dollar index (DXY) going back to 1973 has shown a path of relative stability, with the exception of the major dollar spike in the 1984-1985 period. Big increases in government spending to revive the economy back then drove up long-term interest rates, thereby attracting capital inflows which, in turn, pushed the value of the dollar up, as dollar-denominated Treasuries were highly desirable.
Going back to early October 2023, bond traders started sniffing out that the Fed was about to change the narrative as the inflation data cooled. And they were right. Treasury yields on the long end of the curve have plunged a full 125 basis points since then. When bond yields decrease, the value of the underlying currency tends to decrease as well, especially when factoring in more than $33 trillion in national debt.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
In the past 15 months, the DXY has fallen from 113.3 to 101.2, representing a big devaluation against the basket of currencies noted above. A breach of the 100 level would be technically bearish for the dollar over the near term, inviting another 10-point downside risk. The quandary for the Fed is that they need to see interest rates at exceptionally low levels in order to service the soaring interest on the federal debt.
At the same time, in doing so, currency traders will likely pressure the dollar lower until there is serious conviction at the Congressional level to tackle the budget deficit and the long-term debt balloon.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This is a problematic scenario that must be addressed soon. If the world begins to lose faith in the ability of the United States to resolve its debt burden, then the value of the dollar will very likely break down, forcing bond yields higher to attract capital at Treasury auctions to finance spending and debt service.
This is a monumental problem that has been in the making for years and is now approaching an inflection point. While there is no other world currency that can realistically replace King dollar, there is much consternation about where to find safety from highly leveraged fiat currencies that are losing value, because central banks of developed countries binged on quantitative easing and now sit on tens of trillions of dollars in debt with little to no realistic plans to pay down the debt anytime soon.
Hence, the value of the euro, yen, pound and even Canada’s Loonie are also in protracted downtrends.
So, where is the safe zone?
The Swiss franc.
With a debt-to-GDP ratio under 40%, Switzerland has one of the lowest debt levels in terms of its national output of any developed country, and this ratio is forecast to decrease to 32.6% by 2028.
Switzerland: Falling national debt in relation to GDP, 2018 to 2028
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
In this world of rising debts, this trend is remarkable. Plus, Swiss accounts have always been a storehouse of wealth over generations of global financial upheaval and wars. Shares of the Invesco Currency Shares Swiss Franc Trust ETF (FXF) are, in my view, a strong place to own Swiss Francs in the form of an ETF without having to store the physical currency in a safe or in a safety deposit box at a bank.
The bullish move by FXF shares is a strong indicator of where money is flowing to offset the devaluation of the dollar. Unless the 2024 U.S. election reveals a new voter attitude and conviction to address the debt bomb facing the U.S., owning FXF could be one of the bigger winning trades of 2024 and well beyond.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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