The U.S. dollar shows signs of cracking, and gold is already building ground as precaution. This is not entirely unexpected — there have been predictions of a weakening dollar for years, and the economic leanings of the new president only add fuel to that fire. The question is should gold investors be happy or worried about a weaker U.S. dollar? To sort it out, here’s a quick breakdown on what a weak dollar means and why gold investors may benefit from it.
A Weak Dollar vs. Inflation
When studying currency, be careful about confusing a weaker dollar with inflation. Although the two terms are related and may even exist simultaneously, but the actually describe different phenomena (from a technical economic perspective).
Inflation describes a type of monetary policy effect. Real inflation occurs when a central bank, such as the U.S. Federal Reserve, prints money at a rate faster than the increase in economic productivity. In other words, new money floods the market faster the ability to make new goods and services.
On the other hand, a weakening dollar is more vague. The U.S. dollar could weaken against another currency, such as the Canadian dollar or the Euro. When the dollar weakens in this sense, it means that participants in foreign exchange markets have to trade relatively more U.S. dollars in order to receive other currencies.
In terms of international economics, there are many ramifications of a weaker U.S. dollar. Outside of the Forex market, however, there may still be instances in which “a weaker dollar” refers to a reduction in the purchasing power of domestic dollar-holders – a common repercussion of monetary inflation. In such instances, the prices of goods and services in the United States tend to rise.
A Weaker Dollar: International Ramifications
When the U.S. dollar is strong against other currencies, Americans gain more purchasing power in international markets. It suddenly becomes easier to vacation, buy foreign goods, and invest in foreign companies. Alternatively, foreigners find it relatively more difficult to purchase U.S. assets, including goods, services, and investments.
The flip side is also true. A weaker U.S. dollar means that foreign consumers can enjoy American goods and services. This should increase exports. Americans, on the other hand, should find it relatively more difficult to buy from foreigners. Imports should fall.
Why President Trump May Want to Weaken the U.S. Dollar
President Trump’s economic policy sometimes adopts older protectionist arguments about international trade. Namely, the President believes that the United States wins when it exports more than it imports (a balance of trade surplus). Since the U.S. economy runs a balance of trade deficit, Trump thinks the United States is losing.
Most modern economists reject trade protectionism. Nevertheless, there is one surefire way to promote more exports and discourage imports: weaken the domestic currency in Forex markets.
Protectionists don’t want a strong domestic currency. They want foreigners to have more relative purchasing power so that they can buy American goods. Theoretically, this should support American producers, particularly in visible industries like automotives.
Looking ahead, it appears likely that the President will probably push Congress and urge the Fed to pursue policies that weaken the dollar.
Does a Weak U.S. Dollar Help or Hurt Gold Prices?
The United States holds more gold than any other country, but it is not the top gold producing country (that distinction belongs to China). The United States has to import a lot of its gold. This is when a weaker dollar comes into play.
Imports priced in $USD are more expensive under a weaker-dollar regime, no matter what the asset or commodity. This includes gold. If companies have to pay more dollars to bring in gold, chances are that’s going to bid up the price of gold (at least in U.S. markets). This is why there is, historically, an inverse correlation between the U.S. dollar and gold.
Other potential ramifications of a weakening U.S. dollar includes making foreign holders of U.S. debt nervous, which undermines faith in the United States Treasury and the U.S. economy. When faith in the U.S. economy declines, the price of gold tends to react positively.
Similarly, a weakening U.S. dollar could very well be a symptom of actual monetary inflation. Rising inflation is naturally good for gold prices in nominal terms, and it can have a positive effect on inflation-adjusted gold prices if faith in the economy erodes. People tend to turn to gold as a safe haven when fiat currencies appear under threat.
In other words: A weaker U.S. dollar may be a worrying sign for U.S. consumers and for foreign manufacturers who rely on U.S. demand, but it is likely a good sign for anyone invested in gold, silver, or other precious metals.
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