Monday February 15, 2021 - 16:26:01 GMT
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The Dollar Blow Up Scenario
While the US dollar remains the main global reserve currency, given the loose monetary and fiscal policies being pursued, it pays to consider a scenario that would undermine its reserve role that would see a run on the currency.
What is a Reserve Currency?
According to Investopedia, “a reserve currency is a large quantity of currency maintained by central banks and other major financial institutions to prepare for investments, transactions, and international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the reserve currency, causing other countries to hold this currency to pay for these goods.
The Dollar Blow Up Scenario
I had a discussion with a hi'hly respected market professional, who is also a long time member of the Global-View Forex Forum, on whether the global market needs a currency backed by gold as an alternative to the reserve status of the US dollar. While finding a currency backed by gold (e.g. a gold-backed Deutschmark) is highly unlikely, his comments are worth posting here as they outline a scenario that would see the dollar fall sharply.
The "reserve" era of” the USD is certainly being threatened by the Fed, the treasury now with Yellen in charge, and a president advocating massive additional stimulus. Add to this there is a Congress that will support it.
The Fed will do its best to hold the low end of the curve down for a number of reasons, not the least of which is the interest on the massive debt. If they permit rates to rise, the interest payments could well be a huge budget item, maybe rivaling the military line item.
This may seem unthinkable but it may become increasingly likely. As the Fed holds the lower end of the interest rate curve down, the back end will pop up in response to inflationary expectations. It will look like someone that has stepped on a rake. That's when the dollar will blow up and drop quickly and big time.
Those arguing against the “sky is falling” scenario will likely argue the US currency will remain the main global reserve currency by default, meaning there is no alternative to take its place.
However, those of us that have lived and traded through the “forex wars” know that markets have a way of punishing those currencies that have abused their roles. This does not mean that global markets will abandon the US dollar overnight or even over time, but as pointed out above, there is a scenario that is not so farfetched that it could see a run out of the dollar.
For now, this is just a scenario but suggests there will be periods of volatility going forward. To take advantage of it, I suggest the following
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