Whereas investors have a tendency to move capital to riskier nations to chase higher yields with confidence, they also have a tendency to move capital to safer currencies and countries when risk appetite is reduced. One of the currencies that benefits most from fear is the US Dollar.
Why the Dollar
There are more than a few reasons for why investors trend toward the US dollar when they become fearful:
- Biggest economy – Having one of the biggest economies in the world is a great way to ensure that you are the relative safehaven. When investors start fearing global recession, the United States’ stature as the world’s largest economy makes it a great place to put money.
- Reserve currency – The US makes up roughly 20% of all economic output, but more than 40% of all foreign exchange holdings. The US Dollar is safe in that it is the only currency in the world that is redeemable for commodities like oil, and one of the few currencies that is internationally accepted.
- Political Security – A long history of democracy and low risk of political uprising makes the dollar a safe investment. Political instability in smaller countries makes smaller country currencies a riskier place to put your money.
- Liquidity – Since the US dollar is involved in 40% of all foreign exchange transactions, there is plenty of liquidity should investors need to swap their dollar holdings for local currencies.
- Financial sector – US companies, especially US banks, participate in global business, and they all keep their books in US dollars. With a strong financial sector in New York, Chicago, and in the West, the United States is quite simply a strong international bank.
Risk Example
A great example of the dollar’s perseverance to risk can be found in the 2008 financial crisis. As banks were failing all around the world, and businesses were slowing to a trickle, investors moved out of emerging markets and small countries to store their money in safe assets, particularly the US dollar.
Look at the following charts to see how the financial crisis was quite the boon for the US dollar:
Once investors came to grips with the reality that the financial markets would not come to an end, they were happy to diversify away from the low yielding US dollar to chase higher returns. Thus, the dollar fell in value as investors sold it off for other currencies, and investments:
