The US Dollar and Economy | AWM Insights #151
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Episode Summary
The Dollar became the International Reserve Currency in 1944 to establish a common medium of trade in a war-torn world.
Since then, the Dollar has been trusted by non-US countries to settle transactions for goods, commodities, and services due to its stability, predictability, and broad usage. In recent years, larger countries around the world have been looking to settle transactions in their own currencies.
We discuss the implications of these moves and how it affects the companies you are invested in and your portfolio.
Have questions for an upcoming episode? Want to get free resources, book giveaways, and AWM gear? Want to hear about when we release new episodes? Text “insights” or the lightbulb emoji (💡) to Brandon at (602) 704-5574 to join our new AWM Insights Network.
Episode Highlights:
0:00 Intro
1:03 The US Dollar’s role in the Global Marketplace
4:33 How will Equities perform in a dynamic and evolving currency regime?
7:31 How do interest rates, debt issuance, and trade deficits impact currencies?
9:22 Do shifting factors and forces in currencies impact your returns?
10:24 Why managing volatility and matching your assets to priorities gives you certainty in any environment.
14:10 Text us
+ Read the Transcript
Brandon Averill (00:07): Well, welcome back everybody. We're back for another remote episode of AWM Insights. If you're on-
Justin Dyer (00:14): Hopefully our last-
Brandon Averill (00:14): Our YouTube channel, yeah, hopefully our last YouTube channel, you'll see at least a little bit of what our homes look like. But hopefully this will be the last time, like Justin mentioned, we'll be back in an office next week. But for the time being, we'll get going here. So just want to start off at the top, mentioning that phone number again, we're going to get into just kind of what's going on in the news right now. What are some of the big economic headlines that keep hitting? We're going to talk a little bit about how we're actually managing your portfolio, how we take these things into consideration. But we'd love to get, this is actually a suggestion that did come from one of our listeners and so we're going to throw that number out again because we'd love to hear from you guys and see if you have anything you want us to hit on.
(01:02): And that telephone number is (602) 704-5574. Shoot us a text and we'll dig into some of the topics like we're going to do today. So Justin, let's go there. Let's talk a little bit about some of the things that are floating around in the media. One of the big questions we got that generated this episode, it was the US dollar and what is happening there. The pundits are saying it's going to decline. Or another pundit will hop on and say we're looking at a strength of US dollar. I mean, what does all that mean for our portfolios? How do we look at some of these big headlines that are coming about?
Justin Dyer (01:44): So before we jump into that, how do we look at the headline? Let's make a quick definition of why it's important to be the reserve currency. And there are actually some negative implications to it, but essentially it means that most business in the world is transacted in US dollars. So if somebody from Brazil wants to buy, and this is relevant to the conversation today, but buy a product from China, typically what happens is you convert your Brazilian currency to US dollars, US dollars to Chinese yuan, and then you get your goods back.
(02:20): And that happens because the US dollar is the "reserve currency", it's a reserve currency, and it's been that way for quite some time. The British pound was the previous reserve currency when the United Kingdom had a vast empire throughout the world. And those two things generally go hand in hand. The strongest economy, the strongest country, generally speaking, becomes the reserve currency. It's a benefit because there's a willing buyer for your currency. There's a willing buyer for your country's debt. But on the flip side too, it actually drives your currency up because there's that willing buyer there. So it actually hurts some of your export based manufacturing businesses, service business, et cetera, right? Because it's making your economy more expensive to those outside of your borders.
(03:21): Quite honestly, this topic comes up quite often. Every few years I think it pops back up and it comes up for good reason. And it's probably been a little bit more frequently as of lately because China is trying to assert some sort of dominance on the global stage. And this is one way in which they can add a talking point or a headline that let's say criticizes or pokes at the bear of the United States, our country here. But in all actuality, this is, let's call it a nothing burger, and I could give you a one word answer, certainly go beyond that. But the one word answer is why this is nothing burger is the Chinese yuan is pegged to the US dollar. That literally means that the Chinese currency is a function of the US dollar. It's been that way I think since 1994. They've changed it from a hard peg to a range over time. So it has evolved and it will continue to evolve.
(04:26): But that kind of gives you the answer to, okay, what is behind the headline here? What's the substance? Should the United States or should I be worried? The short answer is that there's no imminent risk of the United States losing its status as reserve currency holder. And even if that were the case, which certainly is a potential over the long term, does that actually have a detriment to your portfolio? It's hard to say. I think the short answer would be probably not. I mean the United Kingdom is a good example. Like I said, that the Great British pound was a reserve currency for some time and when it lost it wasn't necessarily a massive detriment to at least companies within the United Kingdom. So I think again, we can talk more about the dynamics behind all this and why this is coming back to it. But really at the end of the day, the Chinese yuan specifically is pegged to the US dollar. So there really is no immediate risk that the US dollar loses its reserve status.
Brandon Averill (05:33): No, that's super helpful Justin. I think, right, cut even to the chase. At the end of the day, what you're saying is it doesn't matter all that much. When we're planning for your portfolio, when we're investing your money, it's a data input, but it's actually one that doesn't move the needle nearly as much as other considerations. And as we know when we go back to financial structure when we're really putting your portfolio together in a way to achieve your priorities, yes, it's a risk factor that there's a chance the US dollar gets unseated as the reserve currency, but that's more of an issue that we're...
(06:14): Part of the risk spectrum when we're looking at growing your assets over time to meet your priorities, and I'd almost analogize it to what's happening in golf right now. The US is essentially the PGA. There's the LIV tour that's come in, they've created some disruption, et cetera. China, the yuan, everything is growing the economy. It's exciting. People think it's going to threaten the US dollar. Maybe the US makes some adjustments. There's a lot of kind of similarities here, but at the end of the day, LIV still needs to survive and exist. You don't see every big player jumping over there right now because it's still too risky to go make LIV the default golf tournament or golf body in the world.
(07:01): And so people are going to stick with the PGA for the time being, and that might not always be the case, but at the end of the day, those are the types of relationships that may exist. And there's other things, right, Justin? That yes, the reserve currency piece of it, but a lot of times the strength of the dollar to go in another direction is dependent on how easy monetary policy is here in the US or you said it, the desire for debt. So interest rates, is the Fed going to cut interest rates? Are they going to? Potentially as of this morning, there's consideration that we may have another rate hike and all of this is tied to inflation. So maybe even give everybody a little bit of an idea there on, hey, maybe these things are related a little bit and how do those factor into each other?
Justin Dyer (07:55): Yeah, I mean the complexities, I guess is the right word I was trying to reach for there, of the market and rates and currency markets specifically is deep. At any given time, what is dominating market forces is as good as your guess as it is mine. We talk a lot about predicting the future in the [inaudible 00:08:21] and that that exists. But that being said, interest rates are a pretty big variable and factor within currency markets specifically, which you're alluding to. And then bringing that back to the local market. The Federal Reserve uses interest rates or the money supply to really control inflation, which has a knock on effect on the currency markets. Hopefully people are tracking, but there's this vicious cycle, this circular loop of information. And you change one thing here and you don't know what the impact's going to be over there and whatnot.
(08:55): And it's one of the amazing things in the dynamic nature of markets and really one of the reasons you're rewarded for taking risk. But getting to your questions specifically around interest rates and what's going on right now, we've talked about this quite a lot. There is a fight against inflation. How that then trickles down to your portfolio is that it's something we thought about three, four, five years, whenever you became a client, 10 years ago, in your original portfolio construction. The structure of your portfolio trump's economic forecasting. We are setting up a portfolio with the assumption that there will be adversity in the markets. There will be times of, I don't want to say crisis, but pick your dominant narrative. Interest rates are up, earnings are down, we're in a recession, we're in a low interest rate period, we're whatever it is, there's positive and negative forces that can come into the marketplace.
(10:06): Typically speaking the market climbs a wall of worry and you're rewarded for those forces at play. But getting back to the nitty-gritty, and what I was saying is that when we allocate, when we build someone's financial structure, it is with anticipation or hedging for these potential outlier events of higher inflation. And we want to do that in parts of the portfolio that matter. What does that actually mean? Well, equities. Equities are wonderful long-term inflation hedging vehicle or stocks. Over long periods of time, stocks have more than outperformed any period of inflation. Is that true over very short periods of time? No, last year stocks did not outperform inflation. It's pretty apparent that didn't happen. But you're not holding stocks for a one-year period of time to meet a goal or a spending need over a one-year period of time. And so we're matching that asset over a long period of time and we have confidence it will outpace inflation amongst other things and give you a higher expected return to match priorities and goals over the long term as well.
(11:21): But then if we bring it more to the present day, we can actually protect against inflation for more short term, higher priority things. And we use what are called treasury inflation protected securities or inflation protected securities to match up those goals and spending priorities using those type of assets. And those are wonderful things for assets and goals that you don't want to take too much risk. Hey, I need this money in four years or five years, whatever the case may be. But we needed to also keep up with inflation. Okay, we have a vehicle for that and we're not taking an inordinate an amount of risk in order to accomplish that. So we're thinking about that unexpected inflation component. We're thinking about interest rates and by matching an asset with a goal, interest rates, I don't want to say become irrelevant, they're actually still pretty important, but you have a bond maturing when you need it. Interest rates and market price movements over the interim period of time don't matter nearly as much as they do if you're not thinking about portfolio construction in the same way.
Brandon Averill (12:33): I think that's really helpful, Justin. And I think as we just wrap up for today, one thing to remind everybody about is what we're not saying is that we're not paying attention to all of these different factors. Like Justin's saying, is we're actually taking those factors into account when we initially build your portfolio, we build your structure and then we're allowing evidence to inform us and then your priorities to inform us on the way that the portfolio should be structured from an expected return type standpoint. And so all these are important factors over the longer period of time, and will have different impacts on the different investments within your portfolio, whether they're oriented for growth and long-term priorities, or like Justin said, where we need to mitigate the risks of big changes of these over the short term. And we're using certain vehicles like inflation protected securities.
(13:29): So hopefully you guys take away from this there is a very thoughtful approach, but when you hear these news headlines popping all over the place, I think there are things that hopefully you take with a little bit of a grain of salt. We know the evidence says that you can't predict these things. You can't even really adjust on a quick fly to these different events and make predictions and try to take advantage. You try to play all those games, you often lose. So what we're saying is that we are paying attention, but there are greater dynamics that go at play and that's what we're taking into account when we're ultimately building your portfolio. And so, like I said at the top of this episode, we'd love to hear from you guys. If there's any other topics you'd love us to hit on, that telephone number to shoot us a text again is (602) 704-5574. And until next time, own your wealth, make an impact, and always be a pro.