The Daily Dive #102 - Rising U.S. Dollar Index And Exchange Balances
Rising Dollar Index
The DXY (U.S. Dollar Currency Index), which measures the value of the USD against a basket of other fiat currencies, has continued to strengthen over the course of 2021, currently trading at 95.57.
While many investors are rightfully focused on consumer and asset price inflation in the United States, the growing strength of the dollar against other foreign currencies is something to keep an eye on.
Due to the dollar’s role as the world reserve currency, vast amounts of dollar-denominated debt exist offshore, outside of the purview of the Federal Reserve Board. A result of this dynamic is that a rising dollar relative to other foreign currencies (even if the dollar is devalued against real goods services, and financial assets) can cause financial market meltdowns, as a dollar “short squeeze” unfolds, as debtors are forced to sell any USD-denominated assets they may hold to cover their liabilities. Although it was induced by the COVID-19 economic lockdowns, the rise in the DXY in March of 2020 coincided with a crash in global financial markets. This is not a coincidence, but rather simple math. For most global financial assets, bitcoin included, the dollar is the denominator in the trading pair, and if the denominator is increasing in value, the value of the asset will drop as a result.
Notably, throughout much of 2020, the DXY and bitcoin were very closely inversely correlated, as a weakening dollar served as a boon for all dollar-denominated financial assets. Since then however, the two have diverged, with the DXY rising through much of 2021 in tandem with the price of bitcoin.
Does this mean that bitcoin is headed back to around $20,000 because of dollar strength? Absolutely not, as bitcoin is undergoing its own monetization process and adoption curve, but the strength of the dollar against other fiats is notable, and should be acknowledged and watched by investors of all asset classes, because if the trend continues, it could cause a deleveraging across asset classes that presents a fantastic buying opportunity for those looking to acquire bitcoin on the cheap.
It is important to restate that the DXY can rise in tandem with high Consumer Price Index readings, and a sustained uptrend in the DXY towards levels seen early in 2020 would assuredly create headwinds for other asset classes that trade against the dollar, bitcoin included.