Dollar Illusion: Rising Markets Mask Hidden Currency Risks
A rising stock market does not necessarily mean that people are getting richer. In fact, it can be just an illusion created by inflation. When a currency loses value quickly, share prices can rise simply because it takes more currency units to buy the same assets.
Currently, the West is experiencing one of the worst bond bear markets in modern history. The US saw its worst 12-month performance for core bonds on record in 2022, while European and British bonds have been under severe strain since then due to inflation shocks and fiscal worries.
Some analysts attribute this turn to August 2021, when the US withdrew from Afghanistan, and February 2022, when Russia invaded Ukraine. They argue that when Western powers lose their grip on overseas economic flows, their banks absorb bigger losses, leading central banks to step in with fresh liquidity, which often finds its way into equities.
This has led to a near-vertical climb of the Nasdaq and S&P 500. However, this trend poses a significant risk for Europe, Britain, and Japan, which are most exposed to a severe currency crisis. The US, with deeper markets and the reserve currency, is expected to face a serious decline rather than collapse.
History offers stark warnings of what can happen when stock markets soar in local-currency terms while investors' real wealth is devastated. In Weimar Germany in 1923, Zimbabwe in 2008, and Venezuela in the late 2010s, stock markets rose significantly, but investors' purchasing power declined sharply.
For NRIs considering an FCNR(B) deposit, it's essential to understand that this type of deposit only protects against a fall in the rupee against the chosen currency. It does not address dollar risk. If the dollar loses value, the depositor may still receive every promised dollar but each one will buy less.
The petrodollar system, which has priced most oil in dollars for decades, is under pressure due to geopolitical tensions and emerging markets' growing influence. Iran claims 'escalatory dominance' in its region and has sought payment in currencies other than the dollar, including the yuan and euro, for passage through the Strait of Hormuz.
As the dollar's global role shrinks, a three-to-five-year dollar deposit may not be a safe haven. Spreading exposure across different assets, such as gold, silver, rupee instruments, or productive land, might make more sense than locking everything into one currency for years.