I don’t often write macro-oriented articles – the fact is, others do it with significantly more background knowledge. However, one area where I believe I excel is the articles aimed at either investors seeking investments in different countries, as well as different currencies, seeing as I’m one such investor, have been one for years, and have done an untold number of hours of research and weighing on the subject.
With that in mind, I wanted to take today and talk a bit about how we (both international and domestic investors) could consider the role and future of the American dollar.
The dollar in a non-US portfolio
The reason this subject hits close to home is the dive the USD has taken in terms of value when paired to my own “home” currency, the Swedish krona. In my articles that serve to update investors on a monthly basis, I often detail how the impact of a moving USD impacts my projected monthly dividends, in order to exemplify the direct effects of even small currency movements when your default currency isn’t the US dollar.
In short, my broker/platform doesn’t allow me to actually hold any other currency than the SEK. Whenever I do a non-Swedish trade, the requested amount of foreign currency – euro, USD, Norwegian crown, Danish crown – is immediately converted to SEK, and the trade is made.
The same is true for dividend payouts. While the dividends come in the respective currency, I’m not allowed to hold it as such, and amounts are immediately converted.
I realize that’s not the case for everyone – but I believe that most “common” investors who aren’t professionals use some method of this sort of investment. It also means that any FX effect is felt immediately on the portfolio.
For instance, over the past 2-3 months, the USD has lost more than 10% of its “value” to the SEK. Despite significant multiple expansion in several of my American investments, my total portfolio value has moved very little due to this. At times, the portfolio gains 8-10% despite the market not moving that much, with the SEK weakening.
Since expanding my USD exposure, this is something I’ve become used to. It creates an interesting investing cadence. Let me put it simply.
- During times of a strong dollar, or when I have to pay more than 9-10 SEK for a dollar, times are good because dividends are actually on the rise. Each dividend payout yields markedly better amounts in SEK than before.
- During times of a weak dollar/strong SEK, it’s time to pound capital into US stocks above all others, given that I get “more” for my Swedish money, even if my dividends are comparatively lower in SEK.
Typically and over the last 5 years, the USD has troughed somewhere close to 8 SEK/1 USD. If we expand that to 10 years, we can see times where the dollar has moved as low as 6.5-7 SEK/USD. (Source: XE)
What this means is that despite today’s level of 8.78 SEK seeming a drop towards the more “normal” level…
…the dollar may actually still have some way to fall if it continues weakening further, or if the SEK strengthens.
In the end, I’ve always considered it to more or less even out over time. At times, I’ll pay more for my stocks, at times, I’ll get more from my dividends. It’s worked out fairly well – particularly with my own time horizon of over 30-50 years.
There is a caveat here, however, and it’s the reason for the article.
What if the dollar were to permanently lose its status as the world’s foremost reserve currency?
The risks of the USD in today’s world
I’m not saying things that haven’t already been raised by doomsday prophets and naysayers – and let me reiterate before going into this, that I’m long-term bullish on the dollar. 95% of my current purchases are in USD, and I expect this to continue.
But I wouldn’t be a very good long-term investor if I didn’t diversify as much as I see fit/required – and part of this diversification is purchasing assets based in different currencies. In the future, I may even change to a broker that allows me to actually hold the assets in these currencies to further (and truly) insulate myself.
Let’s cut to the core here.
In 2006-2008, Peter Schiff gained recognition by being one of the few people to “forecast” a global recession/crash. Since that time, he’s been warning more or less constantly that the US may be headed for an even bigger collapse – the day when the world loses faith in the almighty dollar.
Now, I personally see Mr. Schiff/”Dr. Doom” and the position he represents as being too much of an alarmist. Indeed, for many years it seemed that he was considered similarly by large parts of the financial world.
With the COVID-19 pandemic and the resulting fallout, however, Mr. Schiff has started gaining some traction again in the broader financial world. Earlier in July, Goldman Sachs (GS) warned of a real danger of the dollar losing its status as a reserve currency in the global economy and where gold prices are expanding further and further.
This would be an untold shift in the global paradigm. The dollar’s role as a reserve currency is what the entire modern financial system is in part based upon. A shift here would wreak havoc, not in singular stocks but would cause ripples of chaos throughout the entire world. Very little would be spared.
I realize that many of my readers are laymen, and as such, I’ll keep the more complex intricacies of the financial system in the hands of better writers with actual doctorates or degrees in economy.
Simply put, we have the following.
- The dollar risks increasing devaluation as the Fed is pumping out capital in record time and as the U.S government is pouring stimulus packages into the economy to absorb the impact of COVID-19 and the surrounding effects.
- July was the worst month for the dollar in 10 years (since the financial crisis), and compared to the euro, the dollar hasn’t been valued as poorly in over 2 years.
- The pandemic has created a situation where the U.S government is forced to increase the deficit to ridiculous amounts. For June 2020, the budget deficit was $863B. The Congressional budget office of the United States of America expects the government’s budget to reach a 2020 deficit of $3700B, or the worst number since WW2. This would be nearly 18% of GDP.
- At the same time, the U.S economy expects to contract 6.5% for 2020, while the US National debt, which was expected to reach 109% of GDP prior to the pandemic, now is expected to rise to 146% of GDP, according to the IMF. This is beyond the levels of the second world war.
- The CBO warns of the real forecast that the Social Security system as well as Medicare will be out of funds in 11 years.
These are some sweat-inducing facts, even for someone like me who holds no more than 26-27% of my assets in the currency.
Critics of this paradigm/trend, such as Peter Schiff, argue that this has been a long time coming. The USA, they argue, has lived beyond its means for many, many years. This has been financed by ever-increasing budget deficits and national debt.
While not taking a political stance on Donald Trump’s presidency, the fact is that these numbers have swelled to untold heights during Mr. Trump’s tenure as leader of the free world – though the question of course would be how other presidents would have fared in the same position.
All of this puts untold pressure on worldwide confidence in the US dollar. Respected economists, including Mr. Stephen Roach, a senior lecturer at Yale University and former chief economist of Morgan Stanley (MS), warns that a collapse of the American dollar is unavoidable, due to among other things the record-low savings rates which will fall even further in the wake of COVID-19.
The question posed by Mr. Roach, and foreign economists as well, is also who exactly will fund this massive deficit. Previously, the world has taken action in defense of the dollar, funding the nation’s deficits through debt purchases. But as the current president has alienated not only parts of Europe, but essentially frozen out all of China, the prospects for such funding have become problematic.
Europe has its own problems, and China has been steadily decreasing its investments in the American dollar in favor of strengthening the yuan.
The result of these lethal ingredients?
A dollar crash would cause either rising inflation or lethal stagflation, which combines a weak growth with rising consumer prices.
Are they correct?
The doomsday prophets of the American Dollar have been crowing away from their pedestals for many years – decades, even. And up until now, they’ve always been wrong. The dollar has always retained its role as the world’s primary reserve currency, and I don’t see a realistic prospect where either the euro or the yuan “take over” as a sort of reserve currency, with the yuan being a particularly ridiculous notion given current trends in China and the long-term allegations of currency manipulation. My own confidence in the Chinese currency should be clear from my direct yuan exposure – 0.00% of my portfolio. I don’t see this changing in any way.
The current market trends do speak in favor of at least a worry for the dollar status – expressed through the ever-increasing price of gold, which for a long time has been seen as classical protection against inflation and worry. It recently reached $2000. Usually, when the stock market expands, gold prices fall.
That has not been the case since March 2020.
Are non-USD currencies safe, then?
You may ask if non-USD currencies are then safer, or “better.” The answer is, “only to a degree.” Given the degree of interconnection between the worldwide financial systems, a shift in dollar valuation has massive implications even for companies domiciled far outside of USD territory.
I’ll use Swedish companies as an example here.
Because the Swedish krona has strengthened 16% in less than 4 months towards the USD. That’s the largest variance in a decade, and it provides an excellent research opportunity.
Sweden has a large amount of cyclical industrial companies in its major indexes. So when the dollar is strong, companies with large portions of dollar sales report massive FX profits.
Take Atlas Copco (OTCPK:ATLKY), one of Sweden’s largest industrial conglomerates. During 1Q20, with the dollar at record strength, the company reported positive FX of 480M, nearly half a billion krona.
2Q20? That would be a negative FX of -90M SEK.
Such effects are of course noticeable. Sandvik (OTCPK:SDVKF), which builds mining equipment and other things, reported similar variance in their FX, from a 1Q20 positive 200M SEK to a negative 28M SEK in 2Q20.
When confidence in the dollar starts swinging, the entire industrial/financial world swings along with it. These effects are not dying down – quite the opposite. Sandvik’s current forecasts look for a negative FX of nearly 250M SEK for 3Q20.
The effects upon Non-USD companies with USD exposure can be categorized into three parts.
First, it’s the transaction effects which arise when a non-USD company has production and costs in Non-USD currencies, but profits in USD.
Second, there are recalculation effects on foreign assets and debt, which affect the overall balance sheet.
Third, there are recalculation effects that arise when profits in foreign subsidiaries are recalculated into Swedish krona.
Historically speaking, the first effect was usually the most significant. that is no longer the case. As companies have internationalized and the world has globalized, most conglomerates and large companies hold non-Swedish subsidiaries and have significant USD income or assets.
These are just the direct effects upon company numbers. We’ve yet to talk about indirect effects, which include companies being forced to share the FX through lowering prices, which impact competition situation and market shares.
Not all Swedish companies suffer from extreme FX – but industrial cyclical companies are among them. Unsurprisingly, the companies that don’t suffer these effects, such as companies that mainly address and exist in Sweden, are amongst the most expensive companies available today. That is with the market already being almost 20% more expensive than the already-expensive NYSE/NASDAQ.
Welcome to why I currently don’t buy Swedish companies.
The companies that enjoy positive effects from this situation are companies that have a high dollar cost but a low/lower dollar income. Which would these be?
Essity (OTCPK:ESSYY) is one example. The Swedish hygiene company that makes toilet paper and other sanitation products enjoys nearly 0.5B SEK positive FX for every 10% rise in the SEK against the USD.
What to do?
What should we do with this information then?
In order not to simply spout about the dangers like some alarmist, I should have some sort of strategy, after all.
My strategy continues to be an appealing diversification of assets/holdings to safeguard against volatility in the currency markets. Take a look at my current FX exposure.
(Source: Author’s Portfolio, Own Calculations)
Of course, this is far from ideal as of yet.
With over 52% SEK exposure including cash, I’m only marginally insulated against FX. I do know investors, however, who hold 100% SEK, or 100% USD. This serves as an alternative example of such portfolios. Despite holding cyclicals, I’ve found a degree of stability in a structure such as this.
My goal is a USD exposure of around 35%, a NOK of around 12.5%, and a euro exposure of around 20% as a sort of baseline – with no real plans for CAD, yuan, yen, or other currencies. I have long-term confidence in the American dollar, and won’t let current trends stop me from following this. At the same time, I remain aware of the risks to the currency.
You may also invest in assets such as gold, valuable metals, and other commodities. I’ve not done this, and I don’t see this as a strategy I’d like to pursue at this time – though this may change going forward.
I can’t and won’t tell you how to handle a growing uncertainty about the US dollar as a reserve currency. My ambition with this article was that this theme seems to become more common, and is no longer only the area of people known colloquially as “Dr. Doom” – but well-respected economists and congressional offices raising long-term, fundamental concerns.
You, as an investor, must decide on how to handle such a potential situation. My recipe is something I focus on through my articles and work here on Seeking Alpha, where I try to point out good investments both inside and outside of the USA. Both inside and outside of various European nations.
Judging by the rise of readers, this is something that at least a part of the SA readership enjoys, and this is where my heart lies.
If you found this article to be interesting, let me know. I don’t often engage in macro articles, and if you’d like me to do more of them (or less of them – also an option!), I’d love to hear from you.
Finally, I wanted to recommend a recent article on a different perspective, but which addresses something of a similar question related to the appeal of US equities during the coming decade – namely this article by Lyn Alden Schwartzer.
I hope you have a pleasant week – stay safe out there!
Disclosure: I am/we are long ATLCY, ATLKF, ESSYY, SDVKF. 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.
Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
Source: Seeking Alpha