There’s a lot of dollar chatter in the daily and I thought I would give a quick explanation.
TLDR dxy is a stupid indicator and you should ignore it
The DXY was introduced at the time of Bretton woods and the weighting is as such:
- Euro (EUR), 57.6% weight
- Japanese yen (JPY) 13.6% weight
- Pound sterling (GBP), 11.9% weight
- Canadian dollar (CAD), 9.1% weight
- Swedish krona (SEK), 4.2% weight
- Swiss franc (CHF) 3.6% weight
The only update since bretton woods was simply to combine several original european currencies into the euro and adding up their weightings arriving at 57.6%, no other changes have been made.
So the DXY is therefore 75% what goes on in the european subcontinent currency space, with some Yen thrown in (safe haven currency) and CAD (commodities).
This is clearly a terrible reflection of the value of the dollar. Where is gold? Where is China? Being heavily European makes sense but not to 57.6%. The EuroZone GDP ~~ China and the European subcontinent GDP ~~ us GDP, with EU international trade > us trade. (2019 numbers) . Global gold value is approximately the GDP of China, with China making up ~14tln to the us ~21tln (2019). Any sensible model including CNY and a properly weighted balance of middle-size economies (AUD, MEX anyone?) on a trade or GDP basis paints a very different picture to DXY.
In summary, if you are watching DXY you might as well just watch EURUSD. If you actually want to try and value the dollar it is much more complicated but also more informative.
As a note on the “reserve status” question: Dollars are not held as reserves per se, mostly longer duration treasuries are held. Actual dollars are used to settle trade balances, with surpluses being recycled through bond purchases into reserves or lending cash to other countries / businesses in dollars. It is not in principle difficult to settle trade balances with other ‘stores of value’. For example, China has a deal with russia to settle commodities trades with notional gold transfers (held in Shanghai) and has a potential deal with Iran allowing trade to be settled with “soft currency” like Thai Baht if China wants to. The EU had a deal with Iran to settle trade using a literal barter system in order to preserve the Iran Nuclear Deal without getting sanctioned, although it eventually collapsed.
A lot of people have been saying “there’s no alternative” but that’s bullshit. Settling trade isn’t rocket science. Saudi, Switzerland and Norway are using us equities as sovereign wealth funds/reserves.
The “reserve status” isn’t propped up by the trading system (although it helps), it is propped up by the network of dollar-debt assets and liabilities held by basically every business and government in the world. Everyone therefore has an incentive for that not to break down, but once it starts to look like the ship could sink, everyone will want to get off ASAP to not be left bagholding assets in a devalued currency and then it definitely will sink.
This is not a prediction with a date assigned to it by the way. It is a certainty that it will eventually happen sometime in the infinite future, but it may not happen this cycle or even this generation. So don’t get too excited about it. As long as you are investing in options and stonks it probably shouldn’t bother you because equities will inflate.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.