Devaluation of the US Dollar
What to expect in this article?
- What is devaluation of currency
- How devaluation of currency impacts us
- Strategies to hedge against the currency devaluation
There is an apparent disconnect between Wall Street and Mainstreet.
This divide has not been as apparent and blatant as it has during this COVID crisis.
As the number of unemployment claims are rising to levels never seen before, Wall Street is rallying at full swing.
In the middle of this disparity and economic unrest, some economists are warning us to brace yet another crisis called Devaluation of Currency.
What is devaluation of currency?
Devaluation of currency is essentially reducing the value of currency.
This can be done through:
- Printing more money: When supply increases, price falls. This simple economic principle applies to everything
- Policy makers decision: Policy makers may decide to ‘devalue’ the currency to keep the country’s exports competitive. The US is a heavy importer, so this strategy, if implemented, could hurt the US more than other countries
- Selling off reserves: A country could dispose its reserves that pegs the fiat and then set a new exchange rate for its own currency (the disposal of reserves to buy its own currency either by taking out of circulation or printing more)
Sometimes devaluation of currency is not voluntary.
Look at countries like Argentina, Venezuela, etc., their currency devalued by multiple folds because their economy was deemed to be unsustainable.
Why devalue the currency?
Countries devalue their currency primarily for following reasons:
Let’s say if I export Saffron from India at 2 bottles per $1. IF India devalues its currency by 50%, now I can get 4 Saffron bottles for $1.
This drop in currency value encourages exports.
Countries like China, India and others who rely on exports (of goods and services) can reap greater economic benefit by devaluing its currency.
When a country notices that its imports far outweigh the exports, it can use the currency devaluation as a buffer measure to balance the trade equation.
Generally speaking, a weak currency encourages people to buy more from the nation (win for exports) and discourages people buying from outside the nation (a loss for imports).
Let’s say you owe me Indian Rupees 75,000, at the time of this writing, that would be around US$1000. Let’s say, India devalues its currency to 50%.
This means, I can still pay you back your Rs. 75,000 with $500.
While this strategy might not be great to service ‘outside’ debts that are denominated in foreign currency, it is a strategy used to service obligations within the country.
Devaluation of the USD in the wake of Yuan devaluation
The US is the number one importer in the world. It ranks number two as an exporter.
In theory, devaluation of its currency may help increase its export footprint.
However, due to recent devaluation of Chinese Yuan, the devaluation of the US dollar could work against the US, in the short term.
For one, devaluation of the US will simply equalize the impact of Chinese devaluation.
Two, it will make the imports more expensive thus might encourage demand for home products thus reducing the reliance on Chinese imports in the first place.
In addition, as things become more expensive in dollar denomination consumer demand could see a sharp decline which will further slow down the economic recovery.
Why should I be worried about devaluation?
Anyone holding their savings in the US dollars might have to pay attention to the possibility of devaluation of the US dollar.
If the US declares that it is devaluing its currency by 30% then your savings lose 30% value overnight.
In reality, the fear might set into the market and crash the valuation even further.
For example, if you were planning to retire with your $100,000 savings and the government devalues the currency by 30%, all of a sudden your $100,000 will only buy you goods and services worth $70,000.
That is a huge blow for people who have meticulously planned the mileage of their savings.
Can the US devalue its currency?
In theory, yes.
The United States has adopted a Strong Dollar policy for over 3 decades now and this gives it the status of global reserve.
If President Trump were to shock the markets to make a mark in global trade, he could order to devalue the US dollar.
If we know anything about Trump, he is all about shocking the world. So the realms of possibility of devaluing the US dollar are not out of the question.
Strategies to hedge against devaluation of currency
Lot of financial gurus and speculators are expecting the US government to use devaluation as a strategy to make good on its debt.
If this were to happen, you don’t want all of your life savings held up in the US dollar which could see a drop in its purchasing power.
Following assets have come to act as ‘hedge’ against any potential volatility in the US dollar value.
While the market is currently hyped up in real estate, it still could offer a safe haven in the event of devaluation of USD.
For instance, if you bought a property for $200,000 today with a fixed interest rate, in the event the US dollar is devalued to say 30%, then someone coming into the market will have to pay $260,000.
And because you have picked up the property for fixed interest, in theory, you could be paying lower interest compared to the rental costs in the post devaluation world.
This strategy may not work if the US undergoes a long recession as a result of devaluation and then falls into deflation (which will reverse the above strategy).
Many financial veterans are turning to Bitcoin because of its deflationary supply and potential to change the financial markets forever.
Obviously, being a relatively new asset class, it is not a guaranteed safe-haven. Although many believe Bitcoin to be Gold 2.0.
A small stake in Bitcoin could turn into ZERO or a 10x of investment. No one knows which side the tide will turn.
Economic models based on demand and supply (and stock to flow ratio) suggest that Bitcoin has only one way to go: UP.
Bitcoin has a history of proving economic models wrong and shocking the world. Will it go upward into millions or crash and burn into oblivion?
Only time will tell.
Gold & Metals
While Bitcoin is considered money of the people and Gold has been regarded as the god’s money by Robert Kiyosaki.
Silver is considered an underdog at this point.
Between gold & silver, the metal duo has been long acting as a safe-haven for market volatilities.
Obviously, you cannot compare Gold and Silver trajectory to that of stock markets or bitcoin since these metals are designed to act as ‘hedge’ not as wealth multipliers.
If looked at the stock market from a macro level, it has been on an upward trajectory, generally speaking.
Even with the occasional recessions and rare depressions, Stock market has in general kept an upward trend from a macro perspective.
Within the stock market, there are some up and coming industries where the returns could be extraordinarily high, like for example:
Blockchain industry: Companies involved with blockchain space could see a great momentum in the coming decade.
Cannabis industry: Cannabis industry is slowly spreading its claws and becoming
mainstream in the similar fashion how Liqor once did.
5G: Beyond the conspiracies surrounding 5G, we know that this is the next phase of the
internet evolution and
BioTech: Whether it is advancing surgeries, or reversing age with stemcell inventions or
simply decoding the DNA to make medicine more personal, BioTech is a place where the next level of innovation will take place.
Artificial Intelligence: We are clubbing Augmented Reality, Artificial Intelligence into one basket and I think this space could hand out handsome returns.
Just because we do not invest in stocks doesn’t mean they are not a viable investment vehicle. DYOR and see if you can find some gems.
Few things to remember
Do not over-correct
You do not want to find yourself in a situation where you invest 100% into any one type of asset and that asset tanks in value.
For instance, if you invest 100% of your fiat into Bitcoin, what happens if Bitcoin crashes?
If you invest 100% in real estate, what if we face deflation instead of inflation and the price tanks or paying mortgages becomes too expensive?
You will then be forced to service a loan that might be higher than the rent you receive.
Point is, you want to hedge into different asset classes so that you are not putting all of your life savings in one type.
Whether we face extreme inflation or deflation, we all need cash on hand to meet our daily needs.
You cannot easily sell your gold or real estate if you need cash flow. Bitcoin’s volatility makes it a bad choice to be looking to liquidate in the time of emergency.
You always want to keep a certain amount of money in liquid fiat to meet your immediate needs while you secure your financial future with an appropriate hedging model.
The topic of devaluation of currency is one that we all need to be at least aware of.
Having an hedging plan to withstand any surprises introduced by market volatility is important so that you are not wiped away, financially speaking.
The above hedging tactics are based on what we are looking to do personally. We cannot tell you what to do.
Thank you for reading and sharing this article. We appreciate you.
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