Why the US dollar might not be the safe haven you think it is

The US dollar strengthened against most of its major peers this week as traders digested the shock attack by Hamas within Israel.

The ICE US Dollar Index DXY, a gauge of the currency’s strength against a basket of rivals, rose 0.5% to 106.52, according to FactSet data.

This is hardly surprising as in times of geopolitical crises, investors typically pile into safe haven assets, such as the dollar and gold.

But with recent developments and shifting global dynamics, is the notion of the US dollar, the global reserve currency being an impervious safe haven still holding true?

To be clear, the dollar is and will remain so for the foreseeable future, the dominant currency in the world.

However, as history teaches us, nothing lasts forever, and there are legitimate reasons to suggest that the dollar’s dominance is in decline. Therefore, in the long-term investors need to take this shift into account in order to grow and protect their wealth.

One of the key reasons why the US dollar may not be as much of a safe haven anymore is the mounting economic vulnerabilities of the United States.

High levels of public debt, persistent budget deficits, and a trade deficit have eroded the fiscal health of the nation. The pandemic, which saw a massive stimulus package being rolled out, only added to the already substantial debt burden. In the long term, these factors can only undermine the dollar’s value and its stability.

The stubborn, multi-decade high inflation of the last 18 months that has prompted the Federal Reserve to implement its most aggressive tightening programme in a generation, has eroded some of the dollar’s purchasing power, leading people to seek alternative currencies.

Over the summer, global rating agency Fitch downgraded the US government’s top credit rating to AA+ from AAA. Fitch cited fiscal deterioration over the next three years and repeated down-the-wire debt ceiling negotiations that puts at risk the government’s ability to pay its bills.

As this was the second major rating agency (after Standard & Poor’s) to strip the US of its triple-A rating, there are serious, legitimate questions to be asked about the long-term trajectory of the dollar.

There’s also the International Monetary Fund’s Special Drawing Rights (SDR) and efforts by countries like China to internationalize the yuan which are challenging the dominance of the US dollar as the world’s primary reserve currency.

As more countries diversify their foreign exchange reserves, the dollar’s status as a safe haven could be further eroded.

Earlier this year, I was one of the first voices to flag the threat to the US dollar’s dominance as Russia and Saudi Arabia eye the Chinese yuan for oil trades.

At the time I highlighted that one of the most significant, but under-reported, outcomes of a three-day summit between Russia’s Vladimir Putin and China’s Xi Jinping was that Putin said Russia is now in favour of using the Chinese yuan for oil settlements.

Separately, two deals, announced a week earlier, will see Saudi Arabia’s Aramco supplying two Chinese companies with a combined 690,000 barrels a day of crude oil, bolstering its rank as China’s top provider of the commodity. It was reported that Saudi Arabia was also in talks with Beijing to settle with the yuan instead of the dollar.

It appears US rivals, led by China, are forming a new major economic bloc. If Saudi Arabia – home to massive oil reserves, which are estimated to be the largest in the world – does move to the yuan, that would lead to an enormous shift in the global economic system.

Oil is one of the most important and widely traded commodities in the world, and it has traditionally been priced and traded in US dollars. This has given the US dollar a dominant role in global financial markets, as countries that want to purchase oil must first acquire US dollars in order to do so.

If oil trading were to shift away from the US dollar, it would dramatically reduce the demand for US dollars, which would lead to a decrease in the value of the US currency.

We’re noticing that global investors are increasingly seeking to diversify their portfolios away from the US dollar.

As other economies, particularly those in Asia, continue to grow, investors are looking for opportunities in emerging markets. This trend also reduces the demand for dollars and weakens its position as a safe haven.

In addition, the rise of digital currencies, including central bank digital currencies (CBDCs) and cryptocurrencies like Bitcoin, presents a challenge to the supremacy of the US dollar. CBDCs could potentially offer a more secure and efficient means of transacting internationally, reducing the need for the US dollar as an intermediary currency.

Investors and policymakers should carefully consider these factors mentioned above when assessing the true safety of the US dollar as a haven in an increasingly uncertain world.

Diversifying investments and exploring alternative assets may be wise strategies in the face of these evolving dynamics.

 Nigel Green is deVere CEO and Founder