This August, as the dollar surged to levels last seen nearly 20 years ago, analysts invoked the old argument that there is no alternative to predict more gains for the mighty greenback, Ruchir Sharma, chairman of Rockefeller International, wrote for the Financial Times .
What happened two decades ago suggests that the dollar is more likely to reach a recent peak than to rise further. Even as U.S. stocks fell when the dot-com bubble collapsed, the dollar continued to rise before entering a downward trend that began in 2002 and lasted six years. Such a tipping point may be approaching. And this time, the decline of the US currency may last even longer.
Adjusted for inflation or not, the dollar’s value against other major currencies is now 20 percent above its long-term trend and above the peak reached in 2001. Since the 1970s, the typical uptrend in the dollar cycle has lasted about seven years; the current boom is in its 11th year. Moreover, fundamental imbalances do not bode well for the dollar.
When the current account deficit remains persistently above 5 percent of gross domestic product, it is a reliable signal of impending financial problems. This is most true for developed countries, where these episodes are rare and concentrated in crisis-prone countries such as Spain, Portugal and Ireland. The US current account deficit is now close to that 5 percent threshold, which has been exceeded only once since 1960. This was during the down cycle of the dollar after 2001.
Countries see their currencies weaken when the rest of the world no longer believes they can pay their bills. The US currently owes the world a net $18 trillion, or 73 percent of GDP, well above the 50 percent threshold that has often predicted past currency crises.
Finally, investors tend to move away from the dollar when the US economy slows relative to the rest of the world. In recent years, the US economy has grown significantly faster than the average rate for other advanced economies, but it is headed for slower relative growth in the coming years.
If the dollar is close to entering a bear cycle, the question is whether it will last long enough and be deep enough to threaten its status as the world’s most trusted currency.
Since the 15th century, the last five global empires have issued the world’s reserve currency (the one most often used by other countries) for an average of 94 years. The dollar has had reserve status for more than 100 years, so its reign is already longer than that of the currency kings that preceded it.
The dollar was supported by weaknesses in its rivals. The euro has been repeatedly undermined by financial crises, while the yuan is tightly controlled by an authoritarian regime. However, alternatives are gaining popularity.
Beyond the Big Four currencies – the dollar, euro, yen and pound – is the ‘other currencies’ category, which includes the Canadian and Australian dollars, the Swiss franc and the yuan. They now account for 10 percent of global reserves, up from just 2 percent in 2001.
Their gains, which accelerated during the pandemic, came mainly at the expense of the US dollar. The dollar’s share of foreign exchange reserves is currently 59 percent, the lowest since 1995. Digital currencies may be getting cheaper recently, but they also remain a long-term alternative.
Meanwhile, the impact of U.S. sanctions on Russia demonstrates just how much influence the U.S. has in a world dominated by the dollar, inspiring many countries to accelerate their search for options. It is possible that the next step is not to a single reserve currency, but to currency blocs.
Southeast Asia’s biggest economies are increasingly making payments to each other directly, avoiding the dollar. Malaysia and Singapore are among the countries that have entered into similar arrangements with China, which has also offered yuan support to countries in financial difficulty. Central banks from Asia to the Middle East are setting up bilateral currency swap lines, also with the intention of reducing their dependence on the dollar.
Today, as in the dotcom era, the dollar appears to be benefiting from its safe-haven status as most global markets fall. But investors are in no rush to buy US assets. They reduce their risk everywhere and keep the money received in dollars.
This is not a vote of confidence for the US economy, and it’s worth recalling that bullish analysts offered the same reason for buying tech stocks at their recent highs: namely, that there is no alternative. That ended badly. This argument is never a viable investment strategy, especially when the fundamentals are deteriorating.
So don’t be fooled by the strong dollar. The post-dollar world is emerging.