The dramatic title above echoes a trend of recent articles we’ve seen preying upon fears that the U.S. will lose its spot as the default global currency of choice. Recent announcements by the International Monetary Fund (IMF) have talked about potentially adding the Chinese yuan as an official reserve currency. The hot take from this has been to infer that it means the U.S. is getting knocked out of the top spot. However, many investors don’t realize that the IMF already considers the euro, yen and sterling as reserve currencies alongside the dollar. The inclusion of the Chinese yuan into the reserve assets of the IMF is more of an acknowledgement to the growing size of the world’s second largest economy (China) than any type of a knock against the dollar. It will not change the fact that the U.S. dollar is still the default for most international financial and commodity transactions.
Many of these headlines would also lead you to believe the U.S. dollar is quickly diminishing in worth. Yet in the last five years we’ve actually seen it gain in value compared to other international currencies by a cumulative amount of 21%1, and it is on par with levels seen in the mid-1970s. Essentially, the dollar is worth as much today compared to other currencies as it was 40 years ago.
Well, OK then, what if the doomsayers are right?
Let’s think about the effects of the U.S. dollar declining: what does that really mean? A well-diversified, global investor likely has exposure to roughly 45 countries represented by 35 currencies other than the U.S. dollar. Take, for instance, a German company that’s trading in Frankfurt at 10 euros. If the U.S. dollar and euro were trading at parity, or 1:1, that investment would be worth $10 to the U.S. investor. If the U.S. dollar then declined in value to be worth 0.50 euros/dollar, then that same investment would now be worth $20, the value rising proportionately to the amount of the dollar decline. Roughly 50% of the global stock market is traded on exchanges outside the U.S. For most diversified investors, having a meaningful portion of their portfolio outside of the U.S. can be a great hedge against potential currency changes.
Looking at actual returns the last five years the MSCI World Index has gained 11.74% annualized, a very solid return2. That’s from the perspective of a U.S. investor but remember, the U.S. dollar has actually been strengthening the last few years, which is a dampening factor to the value of our international holdings. So what about the experience of investors elsewhere? What if we weren’t located in a country with the ‘all important’ ultimate reserve currency status, i.e. the dollar?
An investor located in France investing in the exact same index would have actually realized gains of 15.5% a year2. An investor in Australia would have seen their account grow by 16.5% a year2. Why the discrepancy? Both the euro and the Australian dollar declined relative to the U.S. dollar, so the price increase that occurred on foreign exchanges resulted in larger increases when translated back into the investor’s home currency.
What are these fear articles selling?
Most articles spreading this concern are promoting large investments into metals like gold and silver. We’ve covered gold’s lackluster returns in the past, (see our Gold video), but it bears mentioning that over the last 40 years (dating back to 1975, shortly after coming off the gold standard), the return on gold has been just 4.8%, and silver even worse at 1.9%2. These returns have not impacted the wealth of investors; in fact, they’ve barely kept up with inflation over that same period, with US CPI averaging 3.8%2. And that makes sense since metals like gold or silver do not produce dividends or grow over time. There are no technological breakthroughs which suddenly make the gold brick in your basement grow in size.
Contrast that to owning the great companies of the world — growing, paying dividends and creating capital gains over time, measured again by the MSCI World Index mentioned above, which has averaged 9.8% per year since 1975. Over that 40-year period $1 invested in silver would be worth $113 today, in gold worth $549, but in stocks would now be worth $4,0752.
The Wall Street Journal’s Jason Zweig recently summed up the topic in his article: “Let’s Be Honest About Gold: It’s a Pet Rock.” It’s not to say there is never a reason to hold some small portion in commodities, but the idea that the IMF’s potential actions should push you to move the vast majority of your wealth out of the capital markets and into a few pieces of metal is simply irresponsible.
There were many pundits who predicted that the Japanese yen would become the default in the early 1980s, and there were many more who thought the euro would replace the dollar shortly after its creation in the early 2000s. Chances are the U.S. dollar won’t be the default reserve currency forever; it could be replaced by the Chinese yuan, bitcoin or some method of payment that hasn’t even been invented yet, but that doesn’t mean it’s necessarily bad news for U.S. investors. There are benefits to a depreciating currency, as our exports would become more competitive and our international companies would recognize higher profits from their foreign sales. A more diverse monetary system is likely better for financial stability, and global growth is not a zero sum game — economic gains in China and other countries do not come solely at the expense of others.
By maintaining a globally-diversified portfolio you will also diversify your exposure to multiple currencies and still be able to participate in the capital markets that can help you reach your financial goals. In my opinion, that’s a much better option than hoping the next guy will pay more for your pet rock than you did.