It’s not so much that the dollar has been notably weak in the very recent past—it’s more that the dollar is being assailed as the world’s reserve currency. Now it’s not just the central bank of China that is complaining.
The U.S. has benefited massively since World War II with the dollar as the de facto reserve currency. Because the dollar has become the world’s reserve currency, there is always tremendous demand for dollars. Huge demand for dollars has allowed businesses to borrow dollars cheaply—benefitting mainly U.S. businesses. It has made funding for American companies far more readily available than funding for other international companies, which primarily have to rely on their home market.
The strong demand for dollars has allowed the U.S. government to borrow as much as it wants whenever it wants. While it can be argued that this has been too much of a good thing, it has made financing the U.S. deficit much, much easier than it would otherwise have been.
Foreign creditors are now looking at the current administration’s deficit coming at them like a tidal wave and are beginning to get a little nervous about holding so many dollars and so little of any other currency. If the dollar begins to decline in earnest, I suppose there is the risk that U.S. investors may also decide it would be nice to have a slug of Swiss Francs, Euros, and Aussie dollars, or whatever. If you think the budget deficit is a problem now, just imagine what will happen if the dollar becomes unglued.
American investors aren’t used to thinking about currency exchange rates, but this is one of the consequences of globalization that needs to be considered in your asset allocation.
