The U.S. Dollar: Debt, Deficits And Geopolitical Considerations

Summary

• The US dollar is still the principal international commercial and reserve currency.
• Current US financial policy is not conducive to a continuation of the US dollar’s dominant status.
• The future of the US dollar is uncertain.

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This article examines the prospects of the US dollar. It is a general view of the current situation of the currency and what may be expected in the near future. This writer is of the opinion that the US dollar will decrease in value against other currencies, a very bearish position, and that investors would do well now to diversify their holdings and move, at least partially, into other currencies.

This means adapting in good time to a wholly new global financial environment. Even though the US economy is recovering from the recession caused by repression due to Covid-19 measures taken to limit the spread of the pandemic, it is by no means certain that the US dollar will continue to dominate global finance as it has done so far.

The US dollar is the most important global currency

It is well known that the US dollar is the most important currency for central banks with the US dollar accounting for about 59% of Forex reserves. The US dollar is involved in about 85% of all Forex transactions and is therefore the most important currency for international trade. The US dollar is also the most important currency for sovereign debt

in addition to there being large sums of corporate debt in US dollars internationally while US corporate debt is nearing $10 trillion.

One could also add that US Treasury paper is considered globally to be one of the safest investments. China has even recently bought more US debt and still owns a large amount of US Treasury paper, more than $1 trillion.

The global demand for US dollars will thus continue for several years due to there being so much debt denominated in the American currency.

It is therefore clear that the US dollar has a dominating position in relation to all other currencies. This domination will continue for at least some years.

Current US Financial Policy

The current US federal debt is over $28.2 trillion and will soon hit $29 trillion at the current rate.

The Biden administration is continuing the deficit spending of the previous administration and has proposed still more spending programs. The deficits have to be funded by Treasury debt, and a large portion of this debt is absorbed by the Fed, which now has a balance approaching $ 8 trillion.

FRB: H.4.1 Release - Factors Affecting Reserve Balances - Thursday, April 22, 2021

The huge trade balance deficit should also be taken into account.

What Is the Current US Trade Deficit?

The question that should be asked is how the US can have such a huge trade deficit without the US dollar collapsing. The logical result of such a deficit should have been devaluation of the currency. With the Fed creating money at such a fast rate, devaluation should follow.

A look at the dollar index shows that there is variation in the value of the currency. The GFC brought the dollar down to below 80, and it is now around 91.

Looking back over the last 40 years one can see that the dollar was highest in the mid-80s. The outsourcing (offshoring) of American industrial production had started earlier, but it went on at an accelerated pace after 1980.

Ultimate outsourcing statistics and reports in 2021 | Outsource Accelerator

Despite the trade deficit, the Administration has continued creating huge sums of money, thus increasing the amount of money in circulation. One reason for the creation of more dollars is that the global economy needs US dollars in order to function. The global demand for dollars accounts for the sustained strength of the greenback. This is due to the need for dollars for commercial transactions (Forex) and the large sums of sovereign and corporate debt that has to be serviced.

There is also the demand for US Treasury paper as a safe haven for investments. It would therefore seem that it does not matter what the Administration in Washington does and how much federal debt there is and how large the Administration’s budget deficit is or how large the trade deficit is. As long as there is a demand for dollars, the Treasury can keep on issuing bonds and the Fed can keep on creating as much money as it wants until the demand slackens.

An Uncertain Future

Investors should be aware that very little is entirely certain in finance. Should demand for the US dollar weaken, then the currency would suffer devaluation. Investors should therefore pay attention to factors that could weaken the dollar and/or decrease demand for the dollar. On the one hand, dollar debtors, including sovereign funds and corporations, would be happy to see a devalued dollar since that would mean that servicing their dollar debt would cost less and the principal to repay would be much less as well.

On the other hand holders of US Treasury paper would not welcome dollar devaluation since that would entail that their holdings would be worth less. The PBoC does not want dollar devaluation since that would cost China dearly as it holds over $1 trillion in US paper.

A weaker dollar would also make it more difficult for China to export goods since the renminbi would appreciate. That would not be good for Chinese companies that are heavily dependent on exporting goods. It is consequently clear that the political differences between the US and China might have an effect on trade, but China will continue exporting as much as it can and the US will continue depending on imports from China despite tariffs.

It should also be taken into account that the Chinese planning is not short term but long term. They plan for 20 or 30 or 40 years into the future. The US dollar could be seriously weakened if China started divesting its US paper, but that would have as a result the strengthening of the renminbi. That is something that the PBoC does not want.

The conclusion to be drawn from these considerations is that China will not attempt to bring down the US dollar. It seems rather that the Administration and the Fed think that it is possible to continue with deficit spending and the creation of huge sums of new money and still have the dollar maintain its dominant position in global finance.

The economic recovery now underway in the US is not going to change the penchant for deficit spending, and the Fed is planning on keeping interest rates low. One real problem that has to be faced is the growing inflation in the US. That may well lead to de facto dollar devaluation.

The bottom line for investors is that they should carefully follow developments in the increase of federal debt and of corporate debt besides keeping an eye on inflation. It will also help to consider the size of the trade deficit. This writer is of the opinion that the US dollar in the long run is going to suffer devaluation due to the insouciance of the US government and a rise in inflation as a result of excessive deficit spending. Savvy investors can start diversifying their portfolios now while the dollar is still strong by putting their capital in non-dollar investments, that is, investing abroad.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Data from third-party sources may have been used in the preparation of this material and WWS Swiss Financial Consulting SA (WWW SFC SA) has not independently verified, validated or audited such data. WWS SFC SA accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Please consult your own professional adviser before taking investment decisions. The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy. All investments involve risk, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Data from third-party sources may have been used in the preparation of this material and WWS Swiss Financial Consulting SA (WWW SFC SA) has not independently verified, validated or audited such data. WWS SFC SA accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Please consult your own professional adviser before taking investment decisions. The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy. All investments involve risk, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments.