Anyone over the age of 30 has likely been told by someone younger than them that, “you’re living in the past.”
That’s certainly true in my case. When I started my career as a writer in the 1970s, I began saving newspaper clippings and promotional mailings that seemed especially informative or provocative.
Consider this newsletter promotion from 1985. The headline was a lot like those we see today: “Get Your Dollars Out of the USA Before Uncle Sam Gets Them Out of You.” The copy that followed predicted an imminent collapse in the US dollar’s value, along with hyperinflation.
Of course, neither of these things happened in 1985… or over the next 35 years. Given this, you can understand why we here at The Nestmann Group are more than a little skeptical reading breathless pronouncements of impending gloom and doom for the greenback.
Of course, we know from history that every fiat currency (i.e., currency backed only by the government that issued it rather than by a tangible asset such as gold) in history has eventually collapsed.
And the dollar certainly hasn’t had a good run during the last year. In 2020, the US Dollar Index (DXY), a trade-weighted index of the dollar’s global purchasing power, dropped to lows last seen in May 2018. Since the beginning of the year, the DXY has dropped 6.2% against this currency basket.
But what will happen in 2021? Economist and former chairman of Morgan Stanley Asia, Stephen Roach, predicted last month that the dollar could fall 35% against other major currencies by the end of 2021. His sentiments are echoed by other analysts.
Rick Rieder, Blackrock’s chief investment officer for fixed income, said at last week’s Reuters Investment Outlook summit, “I think the dollar will cheapen from here.” At the same conference, Citibank predicted a 20% dollar decline in 2021. Meanwhile, Goldman Sachs has warned that the greenback is at risk of losing its status as the world’s “reserve currency.”
The dollar’s reserve currency status came about as a result of a 1944 conference in Bretton Woods, New Hampshire. At the meeting, a group of finance ministers and other high-ranking officials from 44 countries declared that the dollar would be “good as gold.” Henceforth, global central banks could exchange dollars they accumulated with the US Treasury at a fixed price of $35 per ounce.
We all know how that worked out. To avoid depletion of US gold reserves, President Nixon in 1971 suspended the dollar’s convertibility into gold. Yet Nixon’s move actually entrenched the greenback’s preeminent status. Since central banks could no longer exchange dollars for gold, they were forced to accumulate dollars.
That situation hasn’t changed fundamentally since 1971, even though the dollar’s value in relation to gold has fallen more than 98%. The domination of the dollar is so complete that more than 60% of global currency reserves held by central banks are dollar denominated. However, that number has slowly declined in recent years; it was 66% at the end of 2015. But one-third of global GDP still comes from countries that have adopted the dollar as either an official or parallel currency. And nearly 90 countries keep the dollar in a tight trading range with their local currency.
Having the world’s reserve currency has numerous benefits. The biggest one, of course, is that it forces other countries to accumulate dollars even while its value is falling. And, American politicians have weaponized the dollar against Uncle Sam’s enemies. For instance, one way the US can enforce sanctions against its long list of adversaries is by making it difficult for those countries to use or accumulate dollars.
These advantages, among others, have led to criticism throughout the world of the “exorbitant privilege” of the dollar’s reserve currency status. However, two conditions would need to be met for that status to end. The most obvious one would be that the dollar becomes significantly weaker against its trading partners. But that alone isn’t enough. There must also be a viable dollar alternative. And in reality, no other currency is a serious candidate for reserve currency status. The euro is the most obvious contender, with central banks holding about 20% of their reserves in this currency. However, if any country pulls out of the Eurozone and reintroduces a weaker domestic currency, its value could fall sharply. This redenomination risk makes the euro a poor reserve currency candidate.
Thus, I don’t see the “dollar party” ending in 2021. But its value could continue to erode. If it does, the same defensive strategies I’ve long advocated will help you deal with the loss of its purchasing power.
At the top of the list is accumulating gold. In the first 50 weeks of 2020, while the dollar fell 6.2% against a trade-weighted basket of currencies, the spot price of gold rose more than 20%. Store your gold securely at home or in a non-bank depository. If you have more than $100,000 of gold, consider keeping a portion of it in a private vault held overseas.
Finally, if you purchase gold that you don’t store yourself, make certain it’s kept in “allocated” storage. With this type of storage, a custodian (e.g. a bank or warehouse) has specific coins or bars that you own set aside. Your gold isn’t part of your custodian’s balance sheet, and if the custodian becomes insolvent, its creditors can’t grab your gold.
Unallocated storage means that you have an ownership interest in a gold pool maintained by your custodian. But you don’t have title to individual coins or bars, and if the custodian becomes insolvent, in most cases you’re just another unsecured creditor. Good luck getting your gold in that instance.
If you’d like to learn more about buying and most recent survey of the gold market, we reviewed how to get started with gold investments. And starting with this issue, we provide in-depth reviews for a number of international private vaults.