The US dollar index has witnessed its largest drop since COVID-19.
It has now completely disconnected from its underlying fundamentals.
This development could have massive implications for the economy and financial markets.
Since the dawn of civilization, every currency that has come into existence has eventually died out and disappeared into irrelevance.
The people holding these currencies saw their wealth completely disappear.
Take the British pound, for example.
In the 1940s, 1 British pound could be exchanged for 5 US dollars.
It was the dominant global currency at the time.
By the 1980s, the British pound was only worth 1 dollar, completely destroying the purchasing power of anybody holding pounds.
This reshaped global trade, economic power, and geopolitics.
The Dollar Under Pressure
Today, it’s not the pound under attack, but the US dollar – the current dominant global currency.
Many are projecting a similar fate to that of the British pound, possibly catalyzed by Donald Trump’s new government policies.
The US dollar index (DXY) has faced strong selling pressure since Trump’s tariff policy announcement on April 2nd.
While it hasn’t been an outright collapse, something concerning has happened that suggests this decline could be more dangerous than it appears:
The dollar has disconnected from US government bond yields.
US government bond yields essentially show us the return on investment you get for owning US dollars.
Throughout the last few years, these yields and dollar strength have been very interconnected, and logically so.
As the return on investment of the US dollar increases, the foreign exchange value should increase as well.
The growing gap we’re seeing now tells us that the dollar has been weakening despite return on investment staying elevated.
This could signal that something in the currency is breaking.
It might mean interest rates need to rise significantly more to stabilize the dollar or that without such a rise, the dollar could face a complete collapse.
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Understanding the Causes
Before making definitive conclusions, we need to understand exactly why this gap has formed:
1) Tariffs slow economic growth
Foreign exchange rates are heavily influenced by local economic growth.
If investors believe Trump’s tariffs will slow growth in the US, it makes sense the dollar would weaken.
This could be temporary though, as the US economy remains strong and leads in key future industries.
2) Reduced global trade volume
Trump’s tariff policies will reduce global trade volume.
Since most global trade is conducted in US dollars, tariffs naturally reduce demand for dollars.
If we’re heading into a world of declining global trade, that could put the dollar on a sustained weakening path.
3) Deliberate currency weakening policy
Most concerning is the possibility that the current administration is deliberately seeking to weaken the dollar as part of its economic strategy.
Trump has frequently expressed wanting a weaker dollar.
A weak dollar makes American-produced goods more competitive, boosts exports, and stimulates the manufacturing sector.
All of these outcomes aligns with Trump’s “Make American Industry Great Again” objectives.
That’s exactly what happened with the British pound in the 1940s…
2 main factors drove the British pound’s devaluation against the dollar.
The British economy had a high trade deficit, meaning the UK wasn’t manufacturing locally.
Currency devaluation made British goods more competitive and stimulated the local economy.
Also, the UK faced a massive debt burden after World War II.
Devaluing the pound made it easier to pay back debt accumulated when the currency was stronger.
The UK government essentially sacrificed the pound’s status to resolve domestic issues of high government debt and trade deficits.
America’s Similar Position
The comparison between 1940s UK and today’s US is not far-fetched.
The US has significantly increased its trade deficit over the last 30 years, with less goods being produced locally.
The US government also has an enormous debt burden, being one of the world’s most indebted countries.
Government debt now surpasses the total size of the US economy, with severe debt accumulation following the financial crisis and pandemic.
This puts the government in a position where it should cut spending and raise taxes to control its budget.
But, both measures are painful.
The less painful alternative is currency devaluation.
This stimulates the local economy and makes debt easier to repay.
In fact, we’re already seeing signs of the US dollar breaking down.
Looking at the US dollar’s exchange rate against the euro (the main currency in the dollar index), we see it has broken below a long-term uptrend that began in 2008.
That’s a serious breakdown!
We weren’t bullish on the dollar during the dips in 2023 and 2024.
Today, we’re not convinced it can recover like before though.
That said, nothing is guaranteed.
If you’re trading the dollar, it’s important to manage your risk carefully.
Protecting Yourself
If you’re holding US dollars and worried about weakening, there are a couple of options (for educational purposes only, not financial advice):
Diversify your currency risk: If you have significant cash, spread it across multiple currencies.
The Swiss franc is one attractive option.
It doesn’t offer much yield, but it has a strong history of holding value vs. the US dollar.
Switzerland has very low government debt, which supports long-term currency strength and investor confidence
Buy assets: A dollar devaluation would create major tailwinds for housing, stocks, gold, Bitcoin, and oil prices.
These hard assets tend to preserve value during currency devaluations.
In fact, we just released a video on how Bitcoin fits into the current macro setup that can be found here.
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