Comparing Economic Reality to the Popular Narrative of the U.S. Dollar

The United States Dollar (“USD”) is the primary reserve currency of the world and is used as the accounting unit for global asset managers, central banks, and international agencies. The USD is also used for invoicing over 2/3 of the remaining global trade and for quoting globally traded commodities. This has resulted in the USD being the reference point for measuring the rest of the world’s economic activity.

The US has run an average current account deficit “CAD” of $0.5 trillion for the last 20 years. Yet, the Dollar Index “DXY” has stayed in a 15% range of 95 level 95+% of the time. No other country in modern times has had the privilege of running a CAD this high and for such a long time, with no significant negative economic consequences.

The value of the USD compared to other currencies is the most important market in the longer term. A serious appreciation or depreciation of the USD can affect the US economy and create directions for all the other markets such as stocks, bonds, commodities, inflation, and economic indicators.

If the USD fluctuates beyond an acceptable range, it could call into question the entire premise of its primary reserve currency status. Over the last 10 years, low USD volatility has given rise to complacency among investors and policymakers. However, with the US running massive twin deficits of over 5% of GDP (almost double the prior levels) and a negative balance sheet of $17 trillion negative Net International Investment Position “NIIP” (75% of GDP), the primary reserve currency status could come into question.

The US dollar is so dominant that 65+ countries peg their currencies to USD and use it as their medium of exchange like Panama. 85% of FX trades are in USD compared to other currencies. Trade and commodity invoicing are overwhelmingly in USD. Even though there may be an imbalance in the US and potential weakness, these embedded uses are unlikely to change quickly or even for a long time.

The core problem lies in the fact that US consumption is far above that of major economies. This overconsumption is largely aided by government policies through large budget deficits and transfer payments as well as ultra-easy consumer credit and the largest per capita retail square feet on the planet. As a result, the US is structured as a consumer-driven, consumption economy with lower savings being encouraged by various insurance and retirement programs.

Leave a Reply