Two Ways to Prepare Now for the Dollar's Fall From Grace

True sports champions almost never do this... Bringing the idea to the world of finance... The 'network effect' of the U.S. dollar – and its benefits... Global reserve currencies don't last forever... Hurting American interests – and pocketbooks... Two ways to prepare now for the dollar's fall from grace...

Legendary golfer Bobby Jones went on an unprecedented run through the 1920s...

In July 1923, at age 21, Jones – golf's most successful amateur ever – beat Scottish professional Bobby Cruickshank in an 18-hole playoff to win the U.S. Open. The victory kicked off an incredible seven-year streak in which Jones won 13 major championships...

In that span, Jones captured the U.S. Open three other times. He beat the field at The Open Championship (also known as the British Open) three times. And he came in first five times at the U.S. Amateur and once in the United Kingdom's The Amateur Championship.

Jones' crowning achievement happened in 1930... He won all four majors of his era in the same calendar year. Sportswriters called it the "Grand Slam." It's a feat that no other golfer has ever accomplished. And then...

He quit.

Jones was just 28 years old when he walked away from competitive golf. (He later helped design Augusta National Golf Club and co-founded the prestigious Masters Tournament. He also competed in the Masters on an exhibition basis from its start in 1934 through 1948.)

It's rare to see true champions in the world of sports go out on top like Jones...

A few others who did it include...

Boxer Rocky Marciano, who went 49-0 from 1947 to 1955 before retiring at age 32 as the only heavyweight champion to finish his career undefeated...

Baseball pitcher Sandy Koufax, who retired at age 30 in 1966 after winning three Cy Young Awards as the sport's top pitcher and four World Series championships with the Brooklyn/Los Angeles Dodgers during his 12-year career...

And football running back Jim Brown, who also retired at age 30 in 1966 after winning his third Most Valuable Player Award and becoming the NFL's leading rusher at the time.

I (Kim Iskyan) am sure you can think of a few other examples in sports history, too. But in today's Digest, I want to bring this idea to the world of finance with a simple question...

What if the U.S. dollar quit while it's still on top?

What if the dollar – the world champion of currencies for generations – acted like Jones, Marciano, Koufax, or Brown... and gave up its reserve currency status?

The thought might sound as exciting as a celebrity athlete walking away at the top of his game, but in reality, this question about the dollar is way more important to consider than, say, how many more majors Jones could have won if he kept playing competitively.

What I'm talking about today cuts to the heart and soul of the global financial infrastructure.

You see, the U.S. dollar's period of dominance is slowly coming to an end anyway... And as I'll explain, in some ways, the American economy could benefit from "pulling a Jones" and leaving the game while it's still the world champion.

But no matter how it happens, such a dramatic shift in the world currency order could have huge implications for your investments over the long term. And fortunately, there are ways to prepare today...

But let's start with why others around the world covet U.S. dollars so much...

Many Americans don't realize that almost every other country in the world craves U.S. dollars. Here's why...

Central banks around the world hold reserves – in currency or precious metals – so they can trade goods abroad or invest in other countries. Some central banks also use it to maintain exchange-rate pegs.

For roughly the past century, the U.S. dollar has served as the world's primary reserve currency... It's the global economy's most important medium of exchange, unit of account, and store of value. Without U.S. dollars, many other countries wouldn't be able to buy oil or gold, sell toys or cars, or invest in hotels or bridges.

What happens when a South Korean (or Thai or Vietnamese) conglomerate wants to buy goods from Brazil (or South Africa or Canada)? They'll likely use U.S. dollars... because that's the common currency between the two parties in many global transactions.

And foreigners use a lot of dollars... It's estimated that more than half – and maybe as much as two-thirds, though no one knows for sure – of all printed dollars are used outside the 50 states.

Seven different countries use the U.S. dollar as their official currency, while 65 others peg their national currencies to it. And in 2019, 88% of all foreign-exchange trades involved the dollar. (The euro was second, with a role in 32% of all foreign-exchange trades in that span.)

Put another way... as an American, if you travel to Sri Lanka or Argentina, you can take some crisp Ben Franklins along and use them to buy local currency at your destination.

But it doesn't work the other way... When folks from countries that don't have a reserve currency – almost everywhere except for the U.S., Japan, and the European Union ("EU") – travel abroad, they leave their normal currency at home and instead carry U.S. dollars.

That's because they know that wherever they go in the world, the exchange office at the airport (or the shady guy on the street corner) won't know what to do with their Sri Lankan rupees or Argentine pesos.

On the flip side, Uncle Sam's money speaks every language on Earth... No matter where you go, you can use your U.S. dollars to buy other money.

This kind of currency 'network effect' is what continues to keep the U.S. dollar on top...

It helps explain why around 60% of the world's currency reserves – or about $7 trillion – are held in U.S. dollars today. The euro is a distant second, accounting for about 20%... followed by the Japanese yen, the British pound, and the Chinese renminbi.

And beyond that, it shows why the U.S. dollar – and U.S. Treasury bonds – are viewed as a "safe haven" asset whenever we experience uncertainty in the markets or global politics.

When things start getting tough, investors turn to an asset that can be bought and sold quickly and easily, and which tends to be stable over time... And that's still the U.S. dollar, even as the U.S. government continues to print more money than ever.

Thanks to the dollar's supreme status, the U.S. government enjoys certain benefits...

In the 1960s, French politician Valéry Giscard d'Estaing called it an "exorbitant privilege."

The U.S. can borrow cheaply – and as we're seeing nowadays, almost limitlessly – from the rest of the world, which remains hungry for dollars. And the government can defer repaying its lenders by constantly rolling over – and increasing – its debt, seemingly forever.

The U.S. national debt now stands at a mindboggling $27 trillion (up 20% in 2020). To put that in perspective, that's roughly $82,000 for every single American citizen.

The Fed can just keep on borrowing... as long as the rest of the world keeps on lending.

And of course, national debt is just part of the picture... There's also state and local debt, as well as unfunded liabilities (future obligations for which funds aren't set aside) for Social Security, Medicare, and other programs that total an even more astronomical $211 trillion.

That's more than six times the value of all residential real estate in the U.S., as estimated by real estate database company Zillow. That's right... every single house, apartment, and backyard man-cave shack in the entire country, combined.

But the thing is, a time will come – and maybe sooner than we think – when folks will turn away from U.S. dollars...

The only way that the American economy can continue to borrow from everyone else is if the rest of the world continues to covet U.S. dollars. And the whole premise hinges on the faith of the rest of the world in the dollar... and more specifically, the U.S. government.

If you don't think you'll be paid back, or if you think the value of the paper you're holding is going to collapse – you're going to want to sell it before either of those things happen.

That faith is being tested right now by the Federal Reserve's rampant expansion of its balance sheet and the extraordinary and unprecedented printing of new dollars...

You see, despite what the government might think, this isn't an endless proposition.

There's a limit to how many new dollars can be created until the global economy calls the U.S. government's bluff... And just because that limit hasn't been reached yet doesn't mean it doesn't exist.

In late July, strategists from investment bank Goldman Sachs warned that nosebleed levels of borrowing by the Fed were triggering "debasement fears" about the dollar – which could bring about inflation and the end of the dollar's dominant position. And just this week, former Morgan Stanley banker Stephen Roach wrote in the Financial Times that the U.S. has "squandered its exorbitant privilege" and that "a crash is looming" for the U.S. dollar.

Faith in the U.S. dollar is linked directly to the credibility of the U.S. government...

Just like you need to believe in the management of a company whose stock you own, big holders of U.S. dollars – most global governments – need to believe that the decision-makers managing the U.S. dollar won't do anything to harm the value of their holdings.

You don't have to like a country or its leaders to hold its currency... But you do need to trust the country's economic policy and the people making that policy. A currency is only as strong as the economy – and the country – standing behind it.

That's where things are starting to look cloudier for the U.S. dollar right now...

Under President Donald Trump, the U.S. has ignored or abandoned long-held security and multilateral arrangements and commitments – such as pulling away from allies in Europe and from NATO, leaving the critical Treaty on Open Skies for arms control, and suspending funding to the World Health Organization in the midst of a global pandemic.

The government also has weaponized trade deals and taken a transactional (instead of partnership-oriented) approach to economic relations with both allies (like European countries) and adversaries (like China). And it has used the dollar payments system for political purposes to punish countries (and individuals) – including Iran, Venezuela, and people and institutions in China and Russia – by denying them access.

The "my way or the highway" approach to economic and geopolitical policy has worked in Trump's political efforts in the U.S. And it still could be enough to get him re-elected in November, even though he currently trails Democratic challenger Joe Biden in most polls.

But it doesn't make investors, or the countries and central banks around the world – up to their eyeballs in U.S. dollars – feel more confident in the country that's standing behind their wealth.

In addition, the late August announcement from Federal Reserve Chairman Jerome Powell that the central bank's inflation target could exceed 2% – as a way to balance periods of lower inflation – isn't what U.S. dollar holders want to hear... Inflation eats away at the real value of fiat currency. And all else equal, that will be bad for anyone who owns dollars.

Of course, the U.S. dollar's slow slide started a long time before Trump took office...

The foundation of U.S. dollar dominance – the U.S. economy – has been losing ground for a while...

The American share of global economic output has fallen from 40% in 1960 to around 25% today. And when it comes to trade, the U.S. now trails the EU and China in terms of overall volume of exports and imports.

American currency dominance only makes sense in a world where the U.S. is the premier global economy... And frankly, that's becoming less true every day.

Meanwhile, the dollar dominance is under attack...

The global reserve currency holdings of the U.S. dollar, as a percentage of total stockpiles, is around the lowest it has been since the 1990s. Smaller countries face pressure to reduce their outsized reserve exposure to the currency of a country that's decreasingly dominant.

At the same time, the euro is enjoying a resurgence... In late July, the European Union agreed (which isn't easy, since all 27 member nations have to fall into line) to issue the equivalent of $860 billion in bonds for pandemic-related stimulus.

In Europe, usually each country sells bonds individually (kind of like Ohio or Virginia going to market – instead of the federal government). The EU raising the funds collectively is a potential turning point toward a bigger global role for the euro, which has long played Pepsi to the U.S. dollar's Coca-Cola.

Plus, Russia and China – both eager to reduce their dependence on the dollar – have increasingly been using the euro, as well as their own national currencies, to pay each other. And just today, China's currency jumped by the most in nearly five years, in part as investors cheered the continued strong recovery of the country's economy.

As powerful countries around the world continue to look to other currencies, the U.S. dollar's position could deteriorate faster...

In 2020, the dollar is down 3.1% against a basket of other global currencies, and down 9.2% from its March highs. In July alone, the dollar fell 4.4% – its worst month in a decade.

That was partly because of escalating concerns over the mismanagement of the COVID-19 pandemic in the U.S... and anticipation that more gasoline would be poured on the embers of the American economy in the form of additional stimulus money.

Just look at its drop over the past couple of years (and especially in recent months)...

As the Financial Times explained in early August, the long-term concerns about the dollar involve a lot more than just what has been happening recently...

There are also more fundamental worries playing out. Gold is soaring to record nominal highs as investors seek an alternative to the U.S. currency. Some are openly asking, once again, whether U.S. institutions are now too weak for the world to rely on the dollar. American politics is becoming even more polarized and potentially dysfunctional just at the moment when the EU is showing new signs of unity and purpose.

And keep in mind, no matter how strong they seem, global reserve currencies don't last forever...

My colleague and Crypto Capital analyst Fred Marion touched on this point in the Digest last November...

As Fred noted, over the past six centuries, there have been six different reserve currencies. Each lasted for around a century... give or take a decade or two. Take a look...

The rise of the U.S. dollar to become the dominant currency in the global economy started soon after World War I. And its position at the top was solidified in 1944... with the Bretton Woods accord that laid out the ground rules for the global monetary system.

In other words, no matter how you measure it, the U.S. dollar is in the final quarter of being the star quarterback in the global financial system... and perhaps, already at the two-minute warning.

What's more, the U.S. dollar's dominance hurts American economic interests – and pocketbooks – in some ways...

In most countries, the local currency only services the needs of the domestic economy. But as we explained earlier, the U.S. dollar does so much more than grease the wheels of the American economy. And one result of this important role is a structural trade deficit...

In order to ensure that enough dollars exist to keep global trade and the world's financial system running, basic math dictates that the U.S. economy must run a trade deficit.

The U.S.'s trade balance with particular countries may differ – that is, the U.S. may import more than it exports from Country A, and vice-versa with Country B. (For example, Trump has focused on reducing the American trade deficit with China as part of his policy.)

But overall, the global economy will always need additional dollars... Everyone else is using dollars for their own purposes – to buy goods or for their own currency reserves, for example.

That means that no amount of trade wars or other barriers (like tariffs) can fix the overall trade deficit of the U.S. And this causes problems domestically, as Foreign Affairs magazine explained in late July...

Dollar hegemony... creates winners and losers within the United States...

The losers are the manufacturers and the workers they employ. Demand for the dollar pushes up its value, which makes U.S. exports more expensive and curtails demand for them abroad, thus leading to earnings and job losses in manufacturing.

The incessant demand for dollars indirectly hurts the American heartland... And this damage will only get worse as the size of the American economy relative to the global economy continues to shrink. More from Foreign Affairs...

As China and other emerging economies continue to grow and the United States' slice of the global economy continues to shrink, capital inflows to the United States will grow relative to the size of the U.S. economy. This will amplify the distributional consequences of dollar hegemony... at the expense of the country's industrial base. It will likely also make U.S. politics even more fraught.

Income and wealth inequality in the U.S. is worse than in almost any other developed country. That's due in part to globalization, changing technology, and the decline of unions over the years. The U.S. dollar's role in the global economy helps make it worse, though.

The industrial heartland of the U.S. – the so-called "Rust Belt" – has been hit the hardest. And of course, that's also where you'll find many of the swing states – where a few thousand votes can sway the result of a presidential election.

The shrapnel of dollar hegemony injures the American economy in other ways...

Remember all that cheap money that the American economy has access to – thanks to everyone else wanting to buy dollars? It's too much of a good thing... The U.S. economy, like most developed economies, actually has plenty of savings to invest.

But the extra cheap financing – from everyone else in the world wanting dollars – is like the second Twix bar in a package. You don't really want it, but it's right in front of you... So you eat the empty additional calories that you know is unhealthy and unnecessary.

In market terms, that wall of money chases diminishing returns, resulting in asset and credit bubbles... which never end well.

Just think about the subprime housing bubble, the financial crisis in 2008 and 2009, and – potentially – today's markets. If the dollar wasn't in such high demand, the risk of periodic devastating bursting asset bubbles would be much smaller – as would the size of those bubbles.

This is a long way of saying there are many reasons why it would make sense for the U.S. dollar to "go out on top" today.

So what if the U.S. government wanted to end the dollar's reign as the king of currencies?

Well, unlike an athlete in his prime, the dollar leaving the field isn't as straightforward as a quick press conference and some tearful goodbyes... followed by a highly paid commentator gig, more time with family, or some other post-playing endeavors that keep it busy.

Dominant currencies have seen their run in the spotlight end for a number of reasons – many of which lurk over the U.S. dollar today.

The dominance of gold and silver coins issued by Rome – the big world power at the time – in the first few centuries ended after multiple cycles of inflation... The controlling government running big fiscal deficits knocked the Arabian dinar off of its perch at the top of the currency heap in the 10th century...

The Dutch guilder lost its currency reserve status in the 1700s, when the Bank of Amsterdam issued too much debt, and lost the confidence of the market and investors.

More recently, the British pound's reign as a reserve currency ended with the declining importance of Britain in global commerce – and as economic interdependence around the world declined after World War I. Later, as we noted earlier, the Bretton Woods agreement formalized the U.S. dollar (and gold) as the basis of the global financial system.

History tells us that the currency of the world's biggest and most important country tends to become a reserve currency... And a number of conditions – inflation, high debt, bad policy management, and just plain greed – can ultimately end its time in the sun.

The underlying symptom, though, has been that enough people lose their trust in the reserve currency to want to try something else...

If history rhymes, even if it doesn't go out on top anytime soon, the dollar likely won't be the global financial traffic-stopper that it is today when our children reach our age.

The U.S. dollar's dominance will end when a combination of factors eventually cause investors, governments, and markets to give up on it.

Ironically, the U.S. government itself and the Fed have limited control over the dollar. They can't just pull it from the game like a pitcher... As we've explained, the dollar is intertwined in the complex web of the global economy.

But the U.S. government can accelerate the process of the dollar losing its status as the global reserve currency – and essentially, it has been doing just that... Escalating debt, increasing inflation (which is now official Fed policy), declining domestic savings rates, and rising deficits are all potent ingredients.

It's also easy to underestimate the importance of American "soft power" in supporting the dollar... If the rest of the world doesn't have confidence in American government and policymakers – and global faith in the U.S. has plummeted in recent years – the dollar's slow slide could accelerate.

The next question is... what would replace the U.S. dollar?

Frankly, that's up to Mr. Market to figure out... The world has changed significantly since the time of Bretton Woods more than 75 years ago, and there isn't going to be a global currency powwow where all the global leaders decide the fate of the U.S. dollar.

Markets respond to government incentives – but they don't bend to the will of politicians.

However, a concerted effort by a group of governments that eventually grows weary of the U.S. abusing its role as global currency steward could push more aggressively for a different route.

One solution could be to see the U.S. dollar's status as the primary reserve currency replaced with a more balanced basket of currencies involving the dollar, the euro, the Japanese yen, and the Chinese renminbi.

Doing that would ease the heavy dependence on the dollar, which would lessen as the American economy continues to cede its dominant position... Over the long term, it would be reasonable to think that the global economic and financial infrastructure would be more stable and safer.

But when you look at it closer, Japan's economy is in the midst of a multidecade decline and slow stroll to irrelevance. And the EU, despite its recent resurgence, is still like the kid who gets sick all the time – Greece crisis today, Italian crisis tomorrow, Netherlands at the throat of Spain the next day.

Meanwhile, China holds more than $1 trillion in U.S. government bonds today... And continued rhetoric from the American government should spur the Chinese to look for alternatives to the dollar.

But in recent years, China has slowed its efforts to internationalize its currency. The renminbi isn't even freely convertible... It's still subject to capital controls... And it's a long way from becoming a global currency – let alone a reserve currency for everyone to rely on.

The answer isn't clear, but the question is...

What will happen when the global economy shifts away from the dollar – whether it's through a bolt out of the blue from federal government, or more likely, as the natural evolution of what has been playing out over recent history?

The modern financial system hasn't experienced this kind of seismic shift in a long time...

No matter how it happens, I see a few consequences playing out...

First, it would likely result in the U.S. government, American companies, and everyday folks like you and I needing to pay higher interest rates. That's because less demand for dollars would cause the cost to borrow to rise. This would hurt consumers and corporate profits...

Right now, despite historically low interest rates, around 8% of the federal budget goes to interest payments. And as you've heard before in the Digest, any significant increase in interest rates could precipitate a "Debt Jubilee" and a monumental debt reset.

If that were to happen, the U.S. dollar would be the wrong asset to own in a flight to safety.

That means you want to look for 'safe haven' investments elsewhere...

As we say often here in the Digest, your wealth will be much safer if you're holding at least a portion of it in the one asset that always holds its value throughout time...

Gold.

We've pounded the table all year long for owning at least some gold in your portfolio... As we said earlier this week, our colleague and Gold Stock Analyst editor John Doody is calling for the price of gold to hit a new all-time high of $3,000 or higher, in response to the dollar's weakening value and whims of politicians addicted to stimulus.

I agree... Gold has a place in the portfolio of every investor considering a post-U.S. dollar dominant world.

Taking it a step further, you should also listen to some of my colleagues – like Crypto Capital editor Eric Wade – and hold another currency that isn't subject to the whims of central banks and politicians...

Bitcoin.

Earlier this year, our founder Porter Stansberry made the case for why everyone should own at least some bitcoin. The dollar's future as the world's reserve currency was squarely part of the reasons why.

Longtime Digest readers know that Porter has long thought the U.S. dollar would lose its place as the world's reserve currency, primarily because of our "bankrupt" government. He just thought it would most likely happen a different way, via gold, with a country like China suddenly announcing it was pegging its currency to the precious metal.

But Porter explained during his "Capitalism In Crisis" presentation with Eric earlier this year that bitcoin has squarely entered the race as the next global reserve currency. As Porter said...

My mistake, of course, was thinking that the solution to the problems was something that we had used to solve them in the past, and of course gold has long been the last bastion of sound money.

But instead, what's happening is that people have discovered bitcoin and they are moving towards it in place of gold.

Look, in the end, the U.S. dollar probably won't leave the scene Bobby Jones-style. Too much is at stake, and the American government has limited ability to pull the plug abruptly.

But the point is... all champions are eventually forced to quit at some point – whether it's when they're at the top of the game or when they're bruised, beaten, and no longer wanted.

Don't wait another minute... Protect your portfolio today, before that happens to the U.S. dollar.

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We went long with today's Digest, so we'll skip the mailbag for a day. But we want to hear your thoughts about the direction of the U.S. dollar and what comes next... So as always, please send your comments and observations to feedback@stansberryresearch.com.

Regards,

Kim Iskyan
Dublin, Ireland
October 9, 2020