In the midst of surging consumer price inflation, a curious phenomenon is unfolding: the U.S. dollar is gaining strength—not in relation to domestic goods and services, but against foreign currencies. This twist in economic dynamics raises questions about the future of currency valuations and investment strategies.
The U.S. dollar index, which gauges the dollar’s value relative to a selection of foreign currencies, recently surged past the 105 mark, reaching its highest point since December 2002. This unprecedented strength recalls the turbulent days of tech stock collapses nearly twenty years ago.
There’s no denying the dollar’s impressive ascent. In 2021, the dollar index climbed over 6 percent, and as of early 2022, it has already gained more than 7 percent. Despite controversial dollar weaponization tactics, the dollar remains the world’s reserve currency.
This past week, however, the dollar index experienced a slight decline. As of market close on May 19, it stood at 102.91. Is this a sign that the dollar has reached its peak, or merely a moment of consolidation before another upward movement?
Historically, the dollar’s potential could be even greater. Back in the mid-1980s, for instance, the index soared to 164—a world vastly different from today, especially since the euro was yet to be introduced.
While it seems unlikely the dollar index will return to its historic high from almost 40 years ago, achieving parity with the euro for the first time in two decades appears feasible. Slow growth paired with persistent inflation in Europe may continue to weigh down the euro. Additionally, the ongoing conflict between Russia and Ukraine, alongside subsequent disruptions to Europe’s natural gas supply, suggests a weaker euro looms ahead.
What does this landscape reveal?
The dollar, despite its numerous shortcomings, is currently viewed as a temporary safe haven. With the Federal Reserve implementing 75 basis points in interest rate hikes this year, it is perceived as taking a proactive stance against inflation. Consequently, the dollar and dollar-denominated assets are attracting the interest of foreign investors.
Insufficient Explanation
You may have encountered the familiar analogies regarding the dollar: it’s the cleanest shirt in the dirty laundry of fiat currencies or the best house in a bad neighborhood.
But does this adequately explain the current situation?
Perhaps. While these metaphors provide some insight, they are ultimately insufficient.
As previously mentioned, the euro is struggling, but it’s not the only currency facing challenges.
In Japan, the scenario is distinct. There, inflation is a modest 1.2 percent—compared to America’s soaring 8.3 percent. Since the catastrophic financial events of 1989 that devastated the Japanese NIKKEI and real estate markets, the Bank of Japan (BOJ) has implemented extensive measures to spur inflation.
The BOJ has engaged in unlimited bond buying and has injected large amounts of capital into Japanese stocks through exchange-traded funds. Infrastructure spending, under the guise of public works, has further inflated the economy.
For all these efforts, Japan’s debt has soared to a debt-to-GDP ratio exceeding 250 percent, yet inflation continues to elude them. With the BOJ unlikely to raise interest rates like its Federal Reserve counterparts, the Japanese yen remains weak against the dollar.
This is the prevailing narrative, albeit with questionable reasoning.
Meanwhile, China’s draconian zero-COVID policies have devastated the value of the yuan. These factors and many others contribute to high demand for the U.S. dollar.
This entire scenario feels somewhat absurd. While the dollar may currently appear robust, it, like all fiat currencies, faces an inevitable decline.
So, what does this mean for gold?
What’s Up With Gold?
Investors in gold within the U.S. may be feeling perplexed by the dollar’s strength. With inflation at a 40-year high, one would presume gold prices are skyrocketing, shouldn’t they?
Logically speaking, yes. Gold is a traditional hedge against inflation. With consumer prices rising uncontrollably, gold, when priced in dollars, should be climbing accordingly.
So, why isn’t that happening—at least not yet?
After reaching $2,039 per ounce in early March, gold’s price has since dropped by 9.7 percent in dollar terms. For those holding cash, now could be an excellent opportunity to invest in gold bullion coins—and silver as well.
It’s essential to remember that gold is a tool for long-term wealth preservation, not a short-term speculative asset. Owning gold allows investors to shield themselves from erosive policies enacted by central bankers and government regulations. This protection will be particularly vital when the dollar’s situation shifts later this year—if it hasn’t already begun to do so.
The U.S. economy appears to be entering a recession—if it hasn’t already. In the first quarter of 2022, GDP declined by 1.4 percent, and the stock market is reacting negatively to these signs of weakness.
In light of this backdrop, Fed Chair Jay Powell faces a challenging choice: continue raising interest rates amid a recession, or reverse course, support financial markets, and allow inflation to persist?
What will be his course of action? It seems likely he’ll attempt to do both.
The Federal Reserve is expected to raise rates by another 50 basis points following the upcoming June FOMC meeting to demonstrate a show of strength after its misguided “inflation is transitory” stance.
However, by mid-summer, signs of a recession will become increasingly evident, prompting the Fed to pause its hikes and eventually lower rates.
In this scenario, the dollar’s status is likely to diminish, paving the way for gold to shine once again.
Consider this: during the last period the dollar was this strong in 2002, an ounce of gold was priced around $320. Over the following nine years, its value skyrocketed by 490 percent, reaching approximately $1,900.
Given the extensive monetary interventions and trends of dollar destruction that have unfolded over the last 14 years, one can reasonably anticipate that gold’s future price increase will far exceed what was experienced in the early 21st century.
Sincerely,
MN Gordon
for Economic Prism
