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US Dollar Softness

The media tends to grab the latest trends and push content to capture the reader's attention. The demise of the US dollar as a reserve currency is a popular topic today. I constantly see crypto and gold firms posting articles on the death of the US dollar as a reserve currency. These companies are capitalizing on fear to convince investors to buy crypto or gold. They are trying to convince the public that the US dollar as a reserve currency is in jeopardy.

The video below was published over a year ago when the dollar was rising. The video is dated, as we are now concerned about the dollar falling, but the principle remains relevant.

Some of the points made are valid, as the US dollar is losing some of its luster as a reserve currency, but it's way overblown. The Federal Reserve Bank's (Fed) aggressive fight to tame inflation is probably the most significant source of the dollar's fluctuating value. As the Fed raises rates, international investors buy dollar-denominated assets, which can offer a higher rate of return in their own country. Likewise, as the Fed lower rates (anticipated), international investors may sell dollar-denominated assets as they may be able to make a higher rate of return in their own country. The table below shows how quickly the Fed ramped up and down the rate changes since March 2022.

The US Dollar Index (DXY) is the value of the US dollar relative to a basket of foreign currencies. The six major currencies included in the index are Euro (57.6%), the Japanese yen (13.6%, the British pound (11.69%), the Canadian dollar (9.1%), the Swedish krona (4.2%), and the Swiss franc (3.6%). As you can see, the US dollar increased substantially in early 2022 as the Fed raised rates. Equally impressive is how fast the US dollar decreased as the Fed moderated the rate increases. The US dollar is down ~10% from the highs set in October 2022.

US Dollar as Reserve Currency is Staying

Since the start of the Russian-Ukrainian war, the geopolitical climate has gotten very dark. In retaliation against Russia, the US and Western countries imposed strict sanctions on Russia and its oligarchs. As a result, Russia was effectively cut out of the US-led financial system. The speed and extent the West could complete this task scared many authoritarian regimes.

Furthermore, The Chinese government has been trying to dethrone the US dollar as the world reserve currency for years. They have formed a loose coalition of governments to try and accomplish this task. This coalition includes Brazil, Russia, India, Saudi Arabia, UAE, and several African states. These countries do a lot of trade with China, so they should have a more significant amount of Chinese renminbi (RMB) in reserve. However, using the Chinese RMB as a reserve currency has many drawbacks. China's financial system is still relatively closed compared to other major economies. Capital controls, limits on foreign investment, and restrictions on the flow of capital in and out of the country can make it difficult for the Chinese RMB to gain broader acceptance in global trade and investment. For example, when I lived in China, I sold my dollars on the black market as I got a better exchange rate. China only allowed me to exchange the dollars I brought into the country, and local people were willing to pay more for my dollars. Capital controls are very tight in China, which isn't appealing to investors or countries. China may deserve to be a more significant percentage of the world's reserve currencies, but it has a long way to go to correct major deficiencies. If the Chinese people were allowed to buy and sell their currency on the open markets, I could almost guarantee that they would buy US dollars and Euros and sell the Chinese RMB.

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