Bold forecasts that miss the mark are often quickly forgotten or swept under the rug by misfiring prognosticators.

Two years ago, we heard forecasts of “a 30–40 per cent decline in the U.S. dollar.” But as everyone now knows, the drop in the dollar didn’t happen. Compared to other developed countries’ currencies, such as the Japanese yen, the dollar is up more than 30 per cent since 2022. Further, since 2011, the dollar is up almost 40 per cent compared to a broad basket of currencies!

So why were the dollar bears so wrong? Popular misconceptions about the dollar’s role in the global financial system mislead investors and policymakers alike. These misconceptions never seem to die. We detail our favorite mistakes so that, hopefully, you won’t repeat them.

The result of human action not design

For much of its early history, the United States had nothing like a universal currency The US followed a bimetallic standard (linked to gold and silver), and paper money was shunned. However, the Panic of 1907 prompted Congress to create the Federal Reserve (Fed).

The Fed later issued “Federal Reserve notes,” lent to banks when liquidity dried up, and enforced “par” settlements for checks across the Federal Reserve System.

Then came a series of crises and some luck. The US’s favourable geographic location during the First and Second World Wars (far removed from most battlefields) allowed it to become the “centre of the global financial system.”Owning about 40 per cent of global gold reserves allowed the US to be one of the only countries that did not suspend convertibility throughout the wars.

But wasn’t the dollar system designed by policymakers at Bretton Woods after the Second World War? In reality, delegates ruled out competing plans as infeasible. In short, the dollar was just the best and easiest option.

In addition, the dollar’s reign had already gone global. The Euro-dollar market was born in the 1920s and was revived in the 1950s because London banks started accepting dollar (and other currencies) deposits and making dollar loans to third parties.

Modern-day crises have only further cemented the dollar’s global reign. During the global financial crisis, the Fed lent USD10 trillion in raw swap amounts to its major foreign counterparties, and again during Covid-19—a sign of just how vital the dollar is to the global economy.

The dollar will soon be displaced by a rival

The dollar is the most dominant currency, and its status has waned little in recent decades. According to the international currency index constructed by the Fed, the dollar has remained a steady leader in forex reserves, transaction volume, foreign currency debt issuance, and international banking claims for as long as data is available.

As for second place? It’s not even close. The Euro scores 23 on the index, one-third of the US level, though greater than the sum of the next three currencies combined – Japanese yen (JPY), British pounds (GBP), and Chinese renminbi (RMB).

Further, in 2015 countries with currencies anchored to the dollar (not counting the United States) accounted for 50 per cent of world GDP. In contrast, euro-linked economies accounted for just 5 per cent (not counting the euro area).

The world is de-dollarising.

The latest dollar bear fad is “de-dollarisation.” The argument is that major economies will prefer to use other currencies to avoid the ire of US policymakers keen to “weaponise” the dollar using sanctions.

De-dollarisation is catchy and alliterative. But it’s also wrong.

First sanctions are common and have been used for a long time. As early as 1935, the US-led League of Nations (predecessor to the United Nations) sanctioned Italy for its invasion of Ethiopia, banning loans and military equipment. In modern times, for military purposes, the US has frozen assets tied to the governments of Libya (2011), Iran (2012), Venezuela (2019), and most recently, Russia (2022).

Second, the benefits of “dollarisation” far outweigh the perceived risk reduction from de-dollarisation. Using the dollar allows you to reach 80 per cent of the buyers and sellers in global trade activity and the deepest and most liquid financial markets in the world.

While instituting sanctions dissuades some countries from holding Treasuries as reserves, it’s unlikely the bulk of dollar reserve holders will dump the dollar. In fact, overseas governments with military ties to the US own nearly three-quarters of the total US debt held by foreign governments.

In short, the benefits of operating in dollars far outweigh the costs of de-dollarisation.

Debt overhang will sink the Dollar

Another common misconception is that the dollar is (always) on the brink of collapse due to excessive debt burden. Headlines often tout the “USD27 trillion in marketable debt outstanding.”

From a first approximation, we find this view tedious. For the last 30 years, one could have said the same thing every day of every month in every quarter of every year. So far, the predictive value is nil, for the cumulation of national debt has yet to lead to higher yields or a debt default.

The debt issue is overstated. The average cost (yield) of US debt is only 3.4 per cent as of July 2024, still much lower than most of the country’s recent history, thanks to the dollar’s status as the global reserve currency and decades of price stability since the 1990s. Unless the Fed funds rate stays above 5 per cent for a few more years, we’d argue that the current trajectory of the US debt burden remains manageable.

 Dollar doubters beware

Contrary to popular belief, there are no viable rivals to the dollar. De-dollarisation may occur to a limited extent and be led by bad actors in the global financial system. Still, users of the dollar system overwhelmingly benefit from trading, borrowing, and saving in dollars. Further, debt burdens do not yet threaten the dollar system’s stability, with debt service costs manageable and dollar debt buyers more eager than ever to hold greenbacks.

While law H.1645 does not impose additional restrictions on how state pension assets are invested, it does make major changes to state energy policy in a move that US law firm Ropes & Grey describes as showing a lack of “regard or consideration for energy conservation or the reduction of greenhouse gas emissions”. 

The latest move from DeSantis is part of a much wider anti-ESG movement from certain states in the US, which appears to be having a notable effect on the how the nation’s institutional investors approach to sustainable investment.

Robeco’s fourth annual survey of 300 investors reveals the US lags considerably its global counterparts when it comes to attitudes towards climate investing.

According to the research only 35 per cent of North American respondents say they prioritise climate investing versus 62 per cent of all those surveyed who say climate change is at the centre of, or is a significant factor in, their investment policy.

The US statistics are even more stark compared to those from Asia-Pacific; a region Robeco describes as world leading in climate investing where 79 per cent of investors say climate change is central to, or a significant part of, their investment policy.

Lucian Peppelenbos, Climate and Biodiversity Strategist at Robeco, says: “The relevance of climate change has dipped in North America, where many investors are, for reasons such as geopolitical uncertainty and US political backlash, shying away from sustainable investing.”

He adds: “This dip in North America explains much of the overall decline in the significance of climate change to investment policies in the last 12 months, as its importance is holding steady in Europe and clearly rising in Asia-Pacific.”

North American investors also lagged their APAC and European peers when setting targets for investing in climate solutions. Overall, 40 per cent of investors surveyed have a general aim to invest more, but for North America the figure fell to 36 per cent. This compares with 42 per cent for Europe and 41 per cent for Asia-Pacific.

Peppelenbos also sees the US anti-ESG agenda as acting as a disincentive to investors in actively engaging with investee companies.

The research shows far more European and Asia-Pacific investors undertaking actions to engage with investee companies than in North America. Indeed, over half of North American investors (55 per cent) are not taking any engagement actions, compared to 22 per cent in Europe and 26 per cent in Asia-Pacific.

Peppelenbos says: “A prime reason for this discrepancy is the backlash to ESG investing in USA, where the topic has become controversial and divisive, leading investors to become more guarded and cautious on it.”

Several US states have established oversight committee to monitor financial services firms that they believe are discriminating against companies based on ESG considerations.

These include Arkansas, Louisiana, Georgia, Missouri and Texas.

The annual study, which spans 200 North American institutional investors, (26 per cent of total 770 global respondents) including 117 in the US representing over USD7 trillion in US assets, gauged institutional investor sentiment on the key trends and drivers impacting the investment landscape, and how they are managing their portfolios accordingly.

Private assets to take bigger role in portfolios and sustainable strategies

Nearly a third (32 per cent) of US institutional investors plan to increase their private asset allocations over the next two years, primarily due to diversification benefits, lower volatility and the potential to garner higher returns than the public markets. Investors had the highest interest in increasing allocation to infrastructure investments, with 42 per cent planning to do so over the next 12 months.

Investors also see private assets as an opportunity to incorporate sustainable and impact investments into their strategy. When asked about some of the key investment themes investors want to allocate to through private assets, 49 per cent of participants listed the technological revolution, followed by 39 per cent seeking to proactively allocate to private investments tied to the energy transition, a theme many believe will spur investment in innovation, creating significant investment opportunities.

Active ownership and engagement, along with impact investing, also ranked highly as preferred private assets investment approaches when it comes to investing in sustainable and impact strategies, and 23 per cent of investors noted that actively engaging with portfolio companies and borrowers to ensure achievement of impact targets is the best way to ensure positive and measurable impact in private assets investing.

That said, obstacles remain, including the limited track record of both financial and sustainability performance of funds and mandates (which 63 per cent cited as an obstacle), and weak sustainability and impact measurement practices of asset managers and investee companies (51 per cent).

“Amid continued volatility and geopolitical uncertainty, investors are looking for opportunities for diversification and returns that align with trends shaping global markets,” says Nick Thompson, Head of Private Asset Sales, North America. “Private assets investing can allow them access to companies and industries at the forefront of major developments, such as the energy transition and technological innovation. Asset classes like private equity and infrastructure investing can offer both high returns and sustainable opportunities.”

Investors harnessing thematic trends through sustainable investing

Institutional investors are prioritising investments with companies that are leaders and aligned with the energy transition. When asked for their preferred approach to investing sustainably, US respondents highlighted thematic (69 per cent, compared to 61 per cent globally) as their top choice. This data illustrates a shift from simply considering ESG as a risk mitigation tool, to identifying and targeting thematic sustainability opportunities arising from macroeconomic shifts.

Despite ongoing arguments about the role of ESG in portfolios, US investors continue to see value. Seventy-four per cent of US investors said that a top three reason for investing in sustainability and impact strategies was the belief that doing so is required to achieve long-term financial returns. Sixty-six per cent stated that they are motivated by the appetite to diversify into new sectors (e.g. nature-based solutions, green hydrogen, the Just Transition, etc), further emphasising investors’ thematic focus.

When it comes to the issues that investors see as most important for them in terms of active ownership, corporate governance was the top theme for all regions followed by human capital management (53 per cent) and human rights (53 per cent) for North American investors. US investors understand the importance of issues around financial inequalities, social and racial disparities and the challenges faced by workers, a topic that our Human Capital Management Research, in collaboration with Saïd Business School, University of Oxford and the California Public Employees’ Retirement System (CalPERS) has addressed. 

Marina Severinovsky, Head of Sustainability, North America says: “As the world grapples with regime shift and the trends of deglobalization, decarbonisation and demographics on the investment landscape, sustainability themes are becoming increasingly important, creating new opportunities for companies and investments that provide sustainable products and services. As a result, investors are looking to identify and allocate capital to these emerging sustainable investment themes. They recognise that they have the opportunity to drive change on real issues that can simultaneously lead to positive portfolio outcomes, which is apparent in investors’ current appetite for thematic investing.”

Inflation, interest rates and geopolitical concerns remain

US investors were split in their confidence level of achieving their return expectations over the next two years: 54 per cent were somewhat confident, while 45 per cent were confident or very confident (4 per cent said they are not confident at all).

Affecting their view are several factors that they believe will impact their portfolios over the next year, including geopolitical uncertainty (54 per cent), tapering of monetary policy (45 per cent) and rising inflation (44 per cent).

Adam Farstrup, Head of Multi-Asset, Americas, adds: “We’re in a whole new age of investing as real rates and inflation pressures remain higher for longer. Further, decarbonisation, deglobalisation and demographics – the factors that make up what we call “The 3D Reset” – will continue to have massive long-term implications for the global economy and sustain these trends. Investors will need to understand the impact of these forces and adapt their investment strategy in order to capitalise on opportunities and avoid risks associated with this rapidly changing landscape.”