The dollar's status as the world’s reserve currency is under threat, according to Orbis’ head of multi-asset, Alec Cutler. With a fiscal deficit of around $1.05trn, the currency has been “overvalued for years” and is more “like an emerging market in terms of its currency”.
Emerging markets “mortgage their future” to create economic activity by racking up government debt to stimulate their own economy. This is “exactly what the US has been doing”.
As a result, the dollar has depreciated 7.8% versus the pound so far this year, which Cutler said will go much further. “The dollar’s status as the world's reserve currency is a dysfunctional system that is slowly coming home to roost.”
If the dollar’s depreciation continues, Cutler identified the Norwegian kroner as having the potential to become the world’s reserve currency. “The kroner is the safest currency in the world by a freaking mile,” he said.
With a $1.8trn sovereign wealth fund and around $400trn in national debt, the country is in a very strong position, he argued, making it much more appealing than the US, which is running a deficit that is “comparable to wartime”.
The currency has been weak so far because Norwegians have relatively low domestic investment and have favoured US assets. If the dollar’s depreciation continues – and Cutler believes it will – Norwegian investors may take their money back home, which could start a rally for the currency.
“When ‘back home’ happens to be the safest place in the world, the Norwegian kroner could absolutely become one of the world's premium currencies,” Cutler explained.
Another option is the Japanese yen, which is the “cheapest currency in the world” but has been steadily improving against the dollar this year.
Part of its appeal is the popularity that Japan is enjoying at present (thanks in large part to the yen’s cheapness relative to other currencies). “People are going to Japan to buy stuff. The Chinese are going to Japan to buy stuff. That's how cheap the yen is,” said Cutler.
“To think in cycles, 15 to 20 years ago you wouldn't dream that could ever be the case. The yen was incredibly expensive. So these currencies, do go in cycles.”
The current situation is “nuts”, as Japan remains one of the most technically proficient and well-educated economies in the world. Even if it does not become a reserve currency, Cutler said the yen is a strong place to invest, although he noted that a long position “can be painful on a weekly, monthly or quarterly basis”.
He is not the only investor to draw attention to the headwinds facing the dollar. Luca Paolini, chief strategist at Pictet, explained “the US could do no wrong” on the global stage historically but the current administration’s fluctuating policies are causing investors to hesitate on dollar-denominated assets.
If volatility continues, the dollar will decline by “around 10-15% over the next five years”, something that will have major implications for investors’ asset allocation and the dollar’s status as the reserve currency.
Paolini said the euro is the most obvious alternative and Europe has been attracting more attention this year due to new fiscal stimulus, such as the German government promising a €500bn infrastructure investment package.
As a result, the euro is becoming more competitive with the dollar, but the “political fragmentation in Europe” will be a headwind against its ability to overtake it, according to Paolini.
However, David Rees, head of global economics at Schroders, said the dollar will not lose its mantle as the world’s reserve currency anytime soon.
Most external trade and debt financing is often carried out in dollars and, while it may be underperforming this year, over the longer term it tends to be a safe-haven asset that is fully convertible anywhere in the world. “Few other assets offer all these factors.”
He conceded that stretched valuations, budget deficits and geopolitical instability due to Donald Trump’s fluctuating trade policy have caused a decline in dollar-denominated assets, but noted “dollar depreciation should not be conflated with de-dollarisation.”
While “diversification of currency risk is a good idea within portfolios”, there is very little to suggest the dollar’s decline will become a long-term trend.
Peter Smith, international equity strategist at Federated Hermes, agreed. Despite the Dollar index (DXY) being down roughly 9% this year, he warned that “questioning the dollar’s reserve standing is a far cry from looking at its temporary position in the exchange-rate ecosystem”.
While the US seems to be faltering in terms of its political stability and ability to pay debts, which is causing a decline in the currency, it remains very attractive in most other regards.
While there are alternatives, “very few are straightforward” and virtually “none of them have enough liquidity to meet global demand”. While some investors might turn to gold, the precious metal has a finite supply and offers no source of income, making it unattractive over the long term, he explained.
“There is no true alternative to the dollar. We believe it will likely remain king for many years, for decades even,” Smith concluded.