Dollar Demise - A False Narrative !!!

As a market watcher we all have grown with the view that whenever there is uncertainty in world, be it economic, political or geo-political, everyone rushes to safe heaven asset i.e. dollar.

But last week, what happened after Trump announced tariff, upended the multi-decade old convention - market instead of seeking refuge to dollar and US bonds safety, rushed to other assets like gold, euro (german bonds), Swiss franc and Japanese Yen. One has to see the outsized move in these assets to see the panic.

No wonder, as a result, dollar index slumped below 100 and US benchmark bond yield saw the wildest move in a week since 2001, from 4.20 to 3.85 to 4.58 to close at 4.49.

In a market size of $29 trillion, such a wild move can easily scare anyone, including US president and we saw Trump blinking. But the way bond yields moved yesterday despite Trump pivot on tariff for non-retaliatory countries, it seems, market wants Trump to blink again.

Will he blink again or not, only Trump knows but one thing is sure, world is not going to be same.

Humanity in modern history, possibly, enjoyed the most prosperous time in last 40/50 years, riding on globalisation and unprecedented growth in international trade. US dollar and its safe heaven status played a critical role in its growth by standardising the nuts and bolts of global trade and creating a whole eco-system around it- right from trade invoicing to secured shipping lines to FX reserves to a liquid and deep capital market for fund raising, to everything that needs to support cross border trade.

It will be very difficult for a single country to carry this burden, unless we are ok with higher frictional cost and a fragmented multi-lateral trading eco-system.

Coming to US, while market chatter is filled with dollar gloom and doom, countries pulling out money from US bonds etc…but question is, what next? Where these countries can park all the funds? As per one of the reports, total foreign ownership in US equities, bonds and credit market is $18.5, $7.2 and $4.6 trillion respectively.

Can Switzerland or Japan or Germany or gold (preferred safe heaven assets right now) absorb $30 trillion of assets without letting their domestic currency and economy impacted, esp when everyone will be desperate to find alternative to US, to exports. Answers will not be easy.

Further, how countries will service or re-finance their dollar debt, running in trillions, with a broken international trading system. The only way for a country to earn dollar is through exports. Given that except for US, no other country can print dollar, it is not going to be easy for them either.

We have seen in past how dollar has behaved with liquidity tightening. We may get into similar situation except that right now, market is focussed more on one side of the narrative looking at price action.

But just to give the perspective, in early 2020 as well, when COVID hit, we saw similar move in dollar index from 101/102 to 90, before recovering all the way to 113. I am not suggesting that it will play out same, but ignoring the well-entrenched role of dollar in global financial system and trade can be a big mistake.

So, as much as reset on international trade is going to be painful for US, dollar and bond, so will be to players sitting on other side of equation with dollar debt. The whole narrative on dollar demise can change with Trump blinking again. He has blinked once and hence can blink again.