The US dollar has long held the omnipotent title of the world’s reserve currency. However, times are changing as various economies drive to reduce their reliance on it and increase their own economic clout. The possibility of the US dollar losing its role as the world’s reserve currency is creating a stir in financial circles. With China, Russia, India, and Brazil challenging the greenback’s dominance, investors need to take note. These four countries, with a combined GDP of around US$ 24 trillion and a population of 3.2 billion – 40% of the world’s population – seek to lessen the dollar’s influence on international finance.
Expectations of political changes include greater international cooperation among governments to establish impartial financial systems and regulations that could lead to a more balanced distribution of wealth worldwide. Economically, we may anticipate increased investment opportunities in world markets as capital shifts from the US dollar into different currencies, stocks, bonds, real estate, and commodities. Such alterations, coupled with the displacement of the dollar as the world’s reserve currency, could have vast global implications that investors should leverage for maximum-gain potential.
Unfortunately, the US has put a spoke in its own wheel with decades of fiscal irresponsibility and sluggish economic growth masked by artificially low-interest rates. Its practice of weaponizing the dollar – as demonstrated by excluding Russia from the international payments system and confiscating its assets – has weakened trust in the dollar worldwide. The repercussions of this are seen in the gradual decline of the dollar’s market share from over 70% 25 years ago to below 60% today. Although the dollar will remain a reserve currency for some time, the rest of the world is actively seeking alternatives in response to the US’s growing unwillingness to refrain from using its reserve currency status to achieve its political goals.
As the US continues to engage in costly foreign wars, its financial position has gradually eroded, leading to a decline in the value of the US dollar. Unlike reserve currency countries that typically enjoy high demand for their debt, the US has seen its bond yields trade at higher rates and lower prices than developed countries like Germany, independent of their inflationary and fiscal realities.
Similarly, after years of paying for costly proxy wars, the US’s current financial situation is causing its currency value to drop. The US dollar index has decreased by 11% since September 2022, while the Canadian dollar has lost 9% against the US dollar and 13% against the euro since mid-2022. This trend is reminiscent of the US’s rise to power after the First World War, which coincided with a drop in bond yields relative to Britain.
Although markets may eventually experience a counter-rally, investors must acknowledge that the US is losing respect among its friends and allies. The erosion of allies represents a significant change in the global economic and political landscape that could result in investors demanding compensation for political risk in the future.
As we shift towards a multipolar world, the US’s relative position is changing, which will affect Canada too. Canadian investors should refrain from assuming that the loonie will miraculously rally to par if the US dollar has chronic problems. We depend on the US economy, and looking offshore to diversify investment opportunities is essential.
Equities in other countries sometimes offer more attractive prospects than in North America, relative to risks. Although the US dollar index has dropped by around 11% since September 2022, the Canadian dollar has lost about 9% of its value against the US dollar and 13% against the euro since mid-2022.
Investors need to remember that we are in a period of change, and the US is losing political and economic respect among friends and allies. Markets, particularly currency markets, never go in a straight line forever, and there will eventually be a counter-rally. However, the first lesson taught in international business is that investors demand compensation for political risk.
Investors looking for a reliable and wise investment strategy should consider diversifying their bond portfolio beyond Canada and the US. Plenty of international bond ETFs are available, including those involving sovereign and corporate debt and combinations of developed and less developed countries. As the world shifts, so too should investor attitudes. While income remains alluring, Germany’s bond yields are only 50 basis points below Canada’s, and many developed countries offer more generous yields than Germany.
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