If you’re like me, and you’re worried about high inflation on the horizon, you’re probably wondering how you can short the dollar.
And by this I mean how can you protect your purchasing power as dollars are being actively devalued by the Federal Reserve?
In this article, we’ll discuss what it means to short the dollar, how to do it, and its inherent risks.
What is Shorting?
Let’s agree that the dollar, like any other currency, is an asset. And if you’re confident that an asset is going to decrease in value, you’ll naturally want to short it.
And by shorting, I mean making profit even as it’s being devalued.
Let’s review three techniques you can use to short the dollar.
How to Short the Dollar
There are several ways you can go about shorting the dollar, which we’ll cover here.
1. Foreign Exchange Markets
The first, and perhaps most obvious, way to short the dollar is through an inverse USD index.
An inverse USD index is an exchange traded fund, or ETF, that will take an inverse approach to the USD’s performance on the foreign exchange market.
So, if the dollar decreases in value on the foreign exchange market, you’d be up.
Sounds like a no-brainer, right? Not so fast.
An inverse USD index will only compare dollars to other currencies. In this way, it’s not the most accurate calculator of a dollar’s value, or purchasing power. It simply measures its relative strength to other currencies, not necessarily goods and services.
For example, if the Federal Reserve is devaluing the dollar at the same time the European Central Bank is devaluing the euro, their relative values against one another won’t change very much.
So using an inverse USD index to short the dollar could be misleading. It might not give you true preservation of purchasing power in many cases.
2. Investing in Anything That Isn’t the Dollar
As you can see, shorting the dollar on foreign exchange markets may not always result in the desired outcome.
Alternatively, consider investing in anything that isn’t the dollar. Because by buying anything that isn’t the dollar, you’re inherently shorting it.
The premise is simple: if you think that one dollar today will be worth less than one dollar tomorrow, you’ll want to invest it in something else that will preserve its value.
And by something else, I really mean anything else. It could be stock in a blue chip company, a stake in a new business, or a real estate investment.
If you invest in a popular commodity, such as gold, your dollar’s value shouldn’t decrease with rising inflation (it might decrease for other reasons, but that’s beside the point). The relative stability of the gold will preserve your purchasing power, all else equal.
That is, the monetary price of that commodity should actually increase as inflation rises for the very reason that its inherent value remains stable.
But buying valuable assets is only one way to short the dollar. Another popular way is one that many Americans might not even realize they’re already doing.
3. Borrowing with Fixed-Rate Debt
Taking out fixed-rate debt is the third and final strategy to short the dollar that we’ll review here.
Let’s say, for example, you buy a $200,000 home with a $100,000 mortgage. Your mortgage is at a fixed-rate of 3.5% for 30 years. This means that the price of that money is fixed at 3.5% interest regardless of rising inflation.
So if the annual inflation rate is, say, 5% – meaning, each year, the dollar is worth 5% less than it was in the previous year – and your home appreciates by the same 5% in dollar terms while your income also increases by 5%, you’ll actually end up in a stronger position.
That’s because you’re paying back your fixed rate loan with cheaper dollars. Effectively, you have 1.5% greater purchasing power relative to your loan payments.
In this scenario, the value of the debt you’re paying off gets cheaper as inflation rises. So you can short the dollar and actually benefit from inflation in the long run.
It’s inflation-induced debt destruction.
The Risks of Shorting the Dollar
As with anything else, shorting the dollar comes with inherent risks.
For one, it requires you to exchange your cash for something else. Whether that investment is a commodity, like gold, a home, or a business, it means that your cash is no longer as liquid.
And your investment can lose real value whether there’s inflation or deflation. There’s always a chance an investment might not work out for a variety of factors that aren’t always a result of monetary policy.
If you attempt to short the dollar by purchasing a home, for example, you run the risk of suffering a real estate market crash, thereby ruining the value of your investment, even if inflation is running hot.
On the other hand, if your income stream is disrupted, you run the risk of defaulting on your loan, or worse – bankruptcy.
What risk you’re comfortable with is entirely up to your own risk tolerance and assumptions.
Protecting Against Inflation
Shorting the dollar is, in essence, an attempt at protecting your money from rising inflation.
The exact method that you use is up to you.
To review, investing in an inverse USD index is one way to short the dollar. The downside is that this often doesn’t give you a full picture of your dollar’s purchasing power, but, rather, its value against other fiat currencies.
Another method is to invest in anything that isn’t the dollar (i.e. investments with real, inherent value). These could be commodities, homes, businesses, or something else entirely. The goal here is to move your assets out of the currency and into things that have real value.
A third, and popular, way to short the dollar is borrowing with fixed-rate debt. Many Americans unwittingly do this when they purchase homes.
The key here is that your interest rate is fixed over time. So when inflation rises, your investment and purchasing power can actually increase thanks to inflation-induced debt destruction.
Whatever the case, make your decisions carefully and invest responsibly. Stay safe out there in the cruel, and often inflationary, world.
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