Betting on USD According to Milkshake Theory

After a negative trading day for the major indexes, stock futures were mostly unchanged overnight in the United States. 

What’s Milkshake Dollar Theory?

A milkshake is usually a delicious treat. But the “Dollar Milkshake Theory” is a market concept that is causing concern for investors all over the world. This theory suggests that the value of the US dollar will rise sharply, which could have negative consequences for investments. Here’s more information on this theory and how you can protect your portfolio from its potential effects.

The milkshake theory basically holds that there are not enough US dollars created to keep up with the rising demand. When the greenback rises high enough, fast enough to lead to defaults abroad, the demand for dollars swirls up and its supply shrinks, leading to an epic squeeze higher. The result is a sovereign debt crisis, a massive devaluation in other currencies, and a likely big blow to your portfolio.

The financial world is like a giant milkshake, with the US dollar as its main ingredient. Of course it is: the whole world depends on US dollars. More than 80% of the world’s trade is done in dollars. Nearly 60% of the money held by the world’s central banks in their “reserves” is in dollars. And governments and corporations all around the world borrow funds – generally, by selling bonds – priced and paid in US dollars. (In fact, there’s more dollar-denominated debt created outside of the United States than inside).

In other words, cash (we believe Ray Dalio meant USD) is not trash as Ray Bridgewater found has led you to believe. At least not according to the aforementioned theory. 

Generally speaking, this isn’t a bad thing. If a foreign company or government has ambitious plans for growth or development, they’re more likely to finance those plans with a loan denominated in US dollars. They know the debt will be easier to access and come with better terms than if they had borrowed in their local currency. And as long as they can make enough dollars to pay the interest on their loan, they can grow faster than they would have without borrowing.

Therefore, access to USD is good for the growth around the globe.

So, when foreign entities struggle to bring in enough dollars to pay the interest, trouble starts to brew. This can be due to a shortage of US dollars or financial difficulties. A strong dollar exacerbates both of these issues.

What Does Strong Dollar Do to Your Portfolio? 

When foreign entities struggle to bring in enough dollars to pay the interest, trouble starts to brew. This can be due to a shortage of US dollars or financial difficulties. A strong dollar exacerbates both. When foreign entities struggle to bring in enough dollars to pay the interest, trouble starts to brew. This can be due to a shortage of US dollars or financial difficulties. A strong dollar exacerbates both of these issues.

Secondly, the sovereign debt crisis may unfold, meaning foreign governments default on their USD denominated debt, leading to deleveraging, that can burry the global economy. 

Interest rates bond fall due to increased interest rates.

When the global financial system crashes, it will drag down all assets with it, including the US dollar. Commodities, private equity, and even cryptocurrencies like bitcoin will not be spared.

The possible exception could be US stocks that mainly depend on the local revenue streams. These can see an initial saleoff, but eventually rise, as one of the few places for investors to hide capital. 

What’s The Angle Here?

Remember, the theory isn’t saying to sell everything and put all your savings in cash.

The greenback is not destined for a correction or permanent decline, but it could see a significant increase in value over the next few months or years.

Second, the theory does not say that the US dollar will not be “debased” or fall in value compared to other currencies. The theory says that the US dollar is likely to rise against other countries’ fiat currencies, but does not rule out the possibility that it might fall compared to non-fiat currencies. So there might still be a case for adding bitcoin (or even gold) to your portfolio.

Brent Johnson himself admits that there is a good chance that he is wrong and the disastrous milkshake scenario will never materialize. Perhaps companies and countries will find a way to reduce all that debt without a disruptive hard landing. Perhaps the world will experience a smooth and efficient transition to some new reserve currency. Perhaps some other factors will stem the rise in the US dollar before too long. 

One way or another, the greenback is having a banner year, outperforming every other major currency. Even if the current rally stalls, the US dollar is still likely to be the best hedge against a simultaneous fall in assets.

ECS Take:

To add a US dollar hedge to your portfolio, you could consider investing in a dollar-based ETF, such as the Invesco DB US Dollar Index Bullish Fund (ticker: UUP, expense ratio: 0.78%).

Another, more prone to volatility, but ultimately more rewarding is to go long on USD against major currencies via a Forex & CFD broker. You can check the list of trusted providers that we use for implementing some of the ideas we’ve been sharing with you lately.

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