Gold American Eagle coins over $100 notes

The U.S. Dollar’s Relationship to Gold and Why It Matters


Written by Philip Diehl

Jul 20, 2023

Measured against a basket of other currencies, the dollar is stronger today than at nearly any other time in the last 20 years. But how long will that strength last, and what does it mean for gold prices?

A stronger dollar can often mean lower gold prices.

Gold bar over $100 notes

A recent article by Bloomberg, published on July 13, 2023, discusses what they call the “resilience” of the U.S. dollar in the face of “aggressive tightening” by the Federal Reserve and the “tide of bearish calls against the greenback” that seems to be taking place.

While the strength of the dollar is an important factor in our economy, it’s also important to the global economy. As the world reserve currency, U.S. dollars are used to purchase many assets and commodities, including physical gold.

For example, a European buyer making a gold purchase would make two transactions: They would exchange euros for U.S. dollars, and then dollars for gold. Since a huge portion of world gold demand comes from outside the United States (more than 95%) and must of that in currencies other than the dollar—a weakening dollar will give foreign currency holders more dollars for their money when executing a gold purchase. So, in this example, gold priced in euros would become cheaper when the value of the dollar falls. And when the price of gold in euros falls, demand for gold in Europe is likely to rise. This example holds for all currencies.

Recently, the dollar has been performing very well.

$1 note with upwards-trending data chart

Let’s get some historical context on how the dollar stacks up against other world currencies. Here is a 20-year chart showing the Federal Reserve’s U.S. Dollar Index, which measures the strength of the dollar against a basket of six other influential currencies: the euro, the pound, the yen, the Canadian dollar, the Swedish krona, and the Swiss franc.

U.S. Dollar Index—20-Year Chart

U.S. Dollar Index—20-Year Chart

Source: Macrotrends

As you can see, the dollar is now near its highest value in 20 years.

We see a similar pattern if we look at the dollar’s performance against the Chinese yuan. Again, the dollar is very strong—at a 15-year peak. This pattern holds with many other currencies, though not all.

Dollar/Yuan Exchange Rate—20-Year Chart
Dollar/Yuan Exchange Rate—20-Year Chart

Source: Macrotrends

This relative strength of the dollar may be one factor acting as a gatekeeper for gold prices, which have performed well in the past year and reached near-record highs but have yet to break records.

The good news is that when the dollar begins to weaken, world gold demand can be expected to rise, raising gold prices (in U.S. dollars) worldwide. But when will the dollar begin to weaken?

What goes up must come down—and that includes the dollar.

Multiple factors drive currency exchange rates, but the big one operating now is the difference in central bank monetary policies—that is, the interest rates these banks are setting vary widely.

Central bank monetary policies are largely driven by whether policymakers want to heat up their economies (by lowering interest rates) or cool them down (by raising rates). Currently, the United States has one of the fastest-growing economies among the largest economies in the world. In fact, our growth rate is considered too high, contributing to higher inflation, despite the Federal Reserve raising interest rates at the fastest pace in its history.

Meanwhile, growth rates in most of the other major economies are middling, weak, or weakening. As a result, their central banks have set interest rates that are lower than rates the Federal Reserve has set. In China’s case, its economy is so weak that the People’s Bank of China (PBC) is actually cutting interest rates.

What does this mean? What goes up must come down. At some point, this big difference in interest rates (between those set by the Federal Reserve and those set by other central banks) will fade or even reverse, leading to a drop in the dollar’s relative strength. Both economic and political forces in the major economies make this inevitable. This is why the Bloomberg article above reports that “fund titans are betting on everything gaining against the dollar.”

However, a weakening dollar does not mean the end of the dollar as the world’s reserve currency or a collapse in U.S. economic power in the world. It doesn’t mean that global “de-dollarization” is underway, a theme that is getting lots of media attention these days. It’s just the natural ebb and flow of currency exchange rates, reflecting differences in the states of national economies and the efforts of their nations’ central banks to manage those economies.

When the dollar drops, gold demand (and prices) may rise.

When the market becomes convinced that the Federal Reserve is ready to stop raising rates—not just pause them—the dollar will have reached the peak of the curve. As the dollar begins its descent and weakens, gold will become more affordable to the rest of the world, increasing global gold demand and allowing for even greater upside potential for gold prices.

This is why today’s strong economy and strong dollar presents a great opportunity for gold buyers.

There are other economic vulnerabilities making the case for gold.

Today’s fast-growing economy has led to higher interest rates and a strong dollar—and in many analysts’ view, overvalued equities as well—at levels that won’t be sustained indefinitely. When the tide turns, I expect that a weaker dollar and falling stock values, combined with stronger economies in the big Asian gold markets, will lead to a resumption in gold’s rally. And if those of us who think equities are oversold are right, and I think they are, a broad stock price correction might also make gold more attractive.

Another factor that may affect gold prices is consumer debt. According to a July 17, 2023, article by The Washington Post, Americans built huge bank balances during the pandemic, then spent that money (and racked up credit card debt) when products finally returned to store shelves. The big question now is whether the massive retail therapy Americans have medicated themselves with since summer 2021 will turn into a case of buyer’s remorse and a new debt crisis. That may depend on whether the strong labor market and wage gains continue.

And then there are commercial real estate markets, which many analysts believe are highly vulnerable today. With so many employees still working remotely, businesses don’t need the office space they required before the pandemic. And when people stopped coming to the office, a lot of stores depending on those customers closed their doors, never to reopen them. If commercial real estate teeters, there is a strong of economic dominoes set up to fall, creating the kind of market uncertainty in which gold prices tend to thrive.

While a strong dollar has its advantages—like making imports and foreign travel cheaper—the prospect for a weaker dollar offers a perfect opportunity to buy gold “on the dip” and ride it upward as the dollar weakens and global demand for gold rises. It’s an excellent time to take a larger position in gold.


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