PWA 2024 Year-End Letter, Part 4: The "December Mess," the Dollar, and Our Go-Forward View

Dear Clients, 

This is the finale to our 2024 year-end message. Please definitely take this one in. Feel free to skip to the summary video at the end. Thanks so much!!

Before we get to the dollar, I'd like to touch on what I'll call the "December Mess" of a market for stocks by quoting derivatives market specialist, and co-host of the uber-popular Market Huddle Podcast, Patrick Ceresna, as he charted the US equity market sector-by-sector during last week's episode:

"You can basically see, there's a monstrous bear market that's already underway, if you're not in the Mag 7s."

Then this from his co-host Kevin Muir:

"Yes, these are terrible looking charts, and the amazing part about is it's the vast majority of the market."

Lastly, Ceresna:

"There was nowhere to hide, if you were not in the Mag 7s... If you were not in the Mag 7s, everything was being decimated."

Essentially, the above echoes the points/concerns I emphasized in our December 18 video, and last weeks Charts of the Day.

Bottom line: It remains a very challenging setup for equities heading into 2025... 

Now, about the dollar.

Conveniently (given that I'm currently penning this piece on the dollar), the two gents who run the Market Huddle podcast also touched on the dollar last week... This will sound very familiar to clients, as it echoes to a virtual T our present view of where the dollar ultimately goes:

Muir: 

"Eventually, USD is going to be for sale. Whether it's this month or next month I don't know, but it's a big long-term top."

Ceresna: 

"In the next couple of years a massive US dollar bear market will be one of the biggest macro moves.  It'll drive a huge commodity bull cycle, driving all sorts of different things.  But what'll be interesting is that it wouldn't shock me if we were halfway through 2025 and we're still waiting for the transition moment of when that's going to happen.  

I do believe it will happen, I do believe you're going to be right, I just don't believe it's going to come as fast as you think it is."

Again, as you clients have heard me say, in person and on multiple occasions on the blog, our very strong view is that the next cycle is going to be characterized by a weaker-trending dollar, which sets the stage beautifully for our global, macro-based investment style. 

The question is simply a matter of when!

This one's going to be relatively easy from here, as our longer-term dollar thesis hasn't deviated from where it was a year ago.

Note, throughout we refer to the next cycle, and that we don't see dollar weakness occurring amid the current cycle, which we're still in, although it's now very long in the tooth.

"The reports of my death are greatly exaggerated."

--The US Dollar

Among the factors that influence the asset mix of a thoughtfully designed global macro portfolio, the manager’s long-term dollar thesis is key.

As for our long-term (the next cycle) macro view, we -- despite the above quote -- anticipate a weaker trending dollar which makes for a global investment setup rich in opportunity.

So why the weak-dollar view?

Well, and make no mistake, it's not because the dollar is in any near-term risk of losing its reserve currency dominance.

Per Brookings, this August:

Reserves. Governments and central banks around the world hold dollar-dominated assets, usually U.S. Treasury debt, as reserves to manage the foreign exchange value of their currencies or weather economic shocks. Dollar assets comprise about 59% of global foreign currency reserves; the next largest share is the euro at 20%.

Borrowing. Foreign governments and corporations borrow money in dollars to insure their creditors against foreign exchange risk; 64% of world debt is denominated in dollars.

Payments. The dollar makes up a large portion of international payments—58% excluding payments within the eurozone—and foreign exchange transactions.

Trade. The dollar plays a major role in global trade. As of 2022, the dollar is used in 54% of foreign trade invoices globally.

The figure below illustrates the dollar’s role in the global economy across six dimensions—foreign exchange reserves, international debt, international loans, international payments, trade invoices, and foreign exchange markets—compared to its primary competitors: the euro, the British pound, the Japanese yen, and the Chinese renminbi.

So, yeah, the rumor of the dollar's imminent demise is greatly exaggerated!

So, again, why our weak-dollar view going forward?

Well, to clarify, when I say "going forward" I'm referring to what we believe the prevailing trend will be during the next cycle... In the near-term -- the rest of the current cycle -- the dollar will be somewhat range bound... 

Beyond whatever's left in the current cycle, here's where we're coming from.

For starters, from a very long-term perspective, the US government debt situation, combined with trillion dollar annual budget deficits as far as the eye can see, is a problem.

Plus, in a world where foreign governments are seeking alternatives to the dollar, one has to wonder if there'll be sufficient demand -- at reasonable rates -- to fund the federal government ad infinitum! 

And, yes, slowly, but surely, the dollar has seen its share of foreign reserves decline over the past couple of decades -- from 70% in 2000 to 59% today:

So, the longer-term question is, is the dollar destined to lose its dominance?

More from Brookings:

"Most economists think not, at least not any time soon. First, in some instances, the dollar’s prominence has increased, not fallen. Outstanding debt securities held in dollars have grown from 49% in 2010 to 64% in 2024, for example.

Second, competitor currencies, like the euro or Chinese renminbi, do not share the attributes that have made the dollar dominant. Most government debt in Europe is issued by individual member states, not by the EU, and the eurozone crisis damaged the currency’s attractiveness. The Chinese government maintains strict capital controls to manage its exchange rates, making it difficult to move money out of the country, and the renminbi is highly illiquid."

While we sympathize with the the-dollar-remains-in-very-good-shape view, there are indeed certain trends -- among policy, debt, and technology -- afoot that bear very close watching going forward.

I.e.:

"What are the challenges to dollar dominance?

Sanctions. Since 2010, the U.S. has increased its use of sanctions. Critics of U.S. sanctions contend that the U.S. has “weaponized the dollar,” especially when the U.S. imposes sanctions without the support of its allies and partners. In China and China-aligned countries like Russia, leaders aspire to bank and trade in their own currencies away from the watchful eyes of Uncle Sam. The Chinese government, for instance, has promoted the renminbi as an alternative to the dollar in trade and development finance as a part of its Belt and Road Initiative. Leaders of the BRICS alliance—Brazil, Russia, India, China, and South Africa—have explored developing a common currency, though most experts give that little chance of success. If the United States is capricious with sanctions, acts unilaterally, and fails to develop a doctrine of economic statecraft, the dollar could be dethroned, Treasury Secretary Janet Yellen has warned.

Debt and dysfunction. U.S. politics are contentious and polarized. Fiscal policy is undisciplined, with the debt-to-GDP ratio rising to new, previously unheard-of heights. Ratings agencies have downgraded U.S. long-term credit. Bickering over appropriations, Congress has shut the government down several times. Further political instability could erode investor confidence in the dollar.

Technology. Innovations in payment technology could reduce the dollar’s role in the global economy. Josh Lipsky, senior director of the Geoeconomics Center at the Atlantic Council, notes that “[de-dollarization] is less about how countries hold foreign exchange reserves and how much are in dollars—which is how we’re traditionally measuring this—versus how money is being settled.” Transactions involving different currencies have long been slow, expensive, and difficult to track in real-time; it was easier to instantly see the value of currency in U.S. dollars than in some less well-used currencies. But that’s changing. As Brookings’ Eswar Prasad explains: “For example, transactions between pairs of emerging market currencies are becoming easier as financial markets and payment systems mature. Typically, converting such currencies to dollars, and vice versa, has been easier and cheaper than exchanging them for one another. But China and India, for example, will soon no longer need to exchange their respective currencies for dollars to conduct trade cheaply. Rather, exchanging renminbi for rupees directly will become cheaper. Consequently, the reliance on ‘vehicle currencies,’ particularly the dollar, will decline.”

Central Bank Digital Currencies (CBDCs) could also upend the dollar’s role as a currency “middleman” by reducing settlement times, making it cheaper and easier to trade non-dollar currencies, and, unlike SWIFT and CHIPS, integrating messaging and payments.

Foreign governments have taken note. In 2015, China built the Cross-border Interbank Payment System (CIPS) which, in addition to integrating messaging and payment systems, allows countries to bypass SWIFT, CHIPS, and the dollar. SWIFT remains much larger than CIPS, though the latter has been growing rapidly in recent years. The Chinese are also developing mBridge, a CBDC. The Federal Reserve has built FedNow, an instant payment network, but the U.S. could fall behind the rest of the world in payment technologies. As Jared Cohen of Goldman Sachs notes, “If the dollar’s position were to change, it would come from evolution, not revolution.”"

So, cutting to the chase, we can surmise that while indeed the dollar remains the only viable world reserve currency option for the moment, and well into the future, there are pressures that will, in all likelihood, continue to mount over the years to come. 

There's volumes more that we can devote herein to support our go-forward dollar thesis, but since it remains what it was a year ago, I'll simply offer up a link to last year's lengthy dollar essay for those of you who'd like a review.

PWA 2023 Year-End Letter, Part 4: The Dollar

And for the grand finale for this year's parting message, here's me on our bottom line going forward:

My parting comment on the video bears repeating:

Clients, we here at PWA know how blessed we are to be working with such a fabulous group of people! We can't emphasize enough what an honor it is that you have entrusted us with the task of growing and protecting your long-term wealth! A responsibility, that, to put it mildly, we do not take lightly!

Thank you!!