There’s considerable ongoing debate regarding the fate of the U.S. Dollar. A parallel consideration is Inflation Vs. Deflation. I’ve heard compelling arguments for each from various professional investors and macroeconomists. We’ll discuss one potential scenario, based on likely actions of the players involved. Primarily the Fed, White House, and Congress in light of their relative interests (or, conflicts of interest depending on your view).
Weighing the Forces
Inflationary (increase money circulation)
The Federal Reserve – Trillions in QE to deliberately generate asset inflation
Long-term low interest rates – Incentivizes borrowing. Lower treasury yields, which favors higher risk investments
Increase in overall money supply
Congress – Increased fiscal spending for stimulus packages and bailouts
White House – Asset inflation improves re-election chances
Deflationary (decrease money circulation)
Corporate insolvencies increasing
MASSIVE debt levels – Individuals (credit card, student debt, auto loans, etc.), corporate, and government
Huge foreign demand for US dollar
“Zombie” companies soaking up money without generating positive cashflow
COVID Lockdowns shutting down multiple business sectors
Changes in consumer habits toward saving and debt reduction
Public pension funds are underfunded
Medicare and Social security are underfunded
Technology – Allows the creation of better things at lower prices and improves individual productivity
The Federal Government – Benefits strongly from inflation. There is no other way to eliminate the debt.
Corporations – Benefit moderately from inflation due to high exposure from debt.
Individuals – Debt free savers are punished from inflation. Indebted spenders are rewarded.
Here’s a long term view of the US Dollar index for some perspective. Historically speaking, the dollar is not terribly strong on a relative basis. The COVID stimulus actions seem to have a relatively mild effect on the dollar. Consider that the fed has been accommodative since 2007, and look at the uptrend in the dollar despite actions that should devalue the dollar. The chart appears to be in a multi-year uptrend after having broken resistance lines from a both multi-decade and multi-year downtrends.
Why then, has the dollar continued getting stronger? In short, the deflationary forces are present on a massive scale for all parties involved. The US Dollar probably is slowly losing value as it strengthens on a relative basis. If the Dollar declines in a global recession, in all likelihood other currencies have gone down even more. In an age of uncertainty, stable currencies such as the Dollar are in high demand. In this case, it’s actually possible for stocks, gold, bonds, and the dollar rise simultaneously AKA the “everything bubble”.
I’ve heard an interesting perspective from a guest featured on Real Vision. I’m unable to find it on the fly, but will add the name as soon as I dig it up. He basically argues that it would be of a net benefit to spend up to $10 trillion to stimulate research and development of AI and other emerging technologies. The U.S. could spend $10 Trillion while remaining at a debt to GDP ratio comparable to other modern economies. Being at a the cusp of bringing a slew of revolutionary innovations to market, the resulting increase in productivity could theoretically offset the resultant inflation. Any resulting recession, he predicts, would be well worth the cost.
I’m not convinced the turbocharged R&D spending is wise, but it’s an interesting concept.
Speculation: While the current path toward modern monetary theory (which isn’t actually modern) is unlikely to stop, I don’t see strong inflation on the horizon in the near term. If the Fed has been unable to achieve its inflation goal for a decade, I assume it’s because they are not able to directly trigger inflation without losing control. I view increasing efforts to trigger inflation as a sign that deflation is in fact, a threat. In other words, the free markets are the main driving force. The US dollars reserve currency status plays a role, as it encourages foreign governments to hold cash reserves and effectively buy dollars which helps support the price. I see deflationary pressures in the next 1-2 years forcing the government’s hand to overextend, possibly igniting a longer term inflation. I do not think this will lead to hyperinflation of the USD. The federal government may be greedy, but it isn’t stupid enough to deliberately destroy one of the strongest weapons in the government’s arsenal and one of our greatest economic advantages – the almighty Dollar. If you’re unfamiliar, google “weaponization of the dollar”.
From a portfolio management standpoint, it may be wise to include hedges for both inflationary and deflationary environments.
Portfolio plays: Hedging Inflation vs. Deflation
Hedges against Inflation
Precious Metals
Commodities
Equities
Real Estate
Short term: treasury inflation protected securities (TIPS)
*Real, hard assets are king
Hedges against Deflation
U.S Dollars
Other stable currencies
Positive yielding investment grade bonds
Treasury Bills
Low beta high yielding dividend-paying equities with very stable businesses. In a deflationary crash, these share prices will also drop with the market but they will continue paying dividends if chosen wisely.
*Liquidity is King
What about Cryptos?
Cryptocurrencies are an interesting play with either outcome. The value proposition with inflation is very straightforward with the digital gold argument. It’s less straightforward with deflation. The deflationary nature of many cryptos given a bullish supply/demand distribution may help certain cryptos retain value more efficiently than other assets should the dollar skyrocket during a deflationary event.
The tug-of-war between inflation and deflation is fascinating and complex. The world’s best investors and economists all disagree.