By Michael Lombardi, MBA
When news first broke from the Federal Reserve that it would slow down the pace of its quantitative easing program, the consensus was that the U.S. dollar would start to rise in value as the Fed would be printing fewer new dollars and actually eliminating all new paper money printing by the end of 2014.
But the opposite has happened.
Below, I present the chart of the U.S. Dollar Index, an index that compares the value of the dollar to other major world currencies.
As the chart clearly shows, the dollar started on a strong downtrend in July of 2013. When I look at the dollar compared to individual currencies like the euro and British pound, the picture looks even worse.
The common belief since the Credit Crisis of 2008: when there’s uncertainty, investors run towards the safety of the U.S. dollar. But something started to happen in mid-2013. Despite China’s economic slowdown, despite the situation with Russia and Ukraine, and with the Federal Reserve cutting back substantially on its money printing program, one would think the U.S. dollar would rally in value—but the opposite is happening.
Two reasons why the greenback is falling in value so fast:
First, world central banks have been slowly selling the U.S. dollars they keep in their reserves, as the percentage of world central banks that use the dollar as their reserve currency has fallen from more than 70% in the year 2000 to just over 60% today.
Secondly, with the Japanese and Chinese reducing the amount of U.S. Treasuries they buy and with the Federal Reserve reducing the paper money it prints each month (that’s billions worth of U.S. dollars that it was using to buy government bonds), who will buy U.S. Treasuries going forward? Will the Federal Reserve have no choice but to reverse its strategy of pulling back on money printing, becoming the buyer of last resort for U.S. Treasuries in 2015 and 2016?
For investors, the continued decline in the value of the dollar brings risk and opportunity. A declining U.S. dollar will push interest rates up, which will push the stock market down and gold prices up as investors seek safety in a new world order of a lower-priced U.S. dollar.