The “Dollar Milkshake Theory” has been a popular topic of discussion in the world of finance and economics recently.
This theory, developed by financial analyst Brent Johnson, attempts to explain what the rising US dollar will mean for the global economy (hint, it’s not pretty).
The theory suggests that a liquidity crunch is coming based off tightening monetary policy, a rising US dollar, and ultra-high debt loads from developing countries.
In this article, we will explore the Dollar Milkshake Theory in more detail, examining its strengths, weaknesses, and potential implications for the global financial system.
The Dollar Milkshake Theory Explained (in simple terms)
The Dollar Milkshake Theory attempts to explain the current market dynamic of an increasing US dollar compared to other global currencies.
The theory was first proposed by Brent Johnson of Santiago Capital, and suggests that the US dollar will continue to strengthen significantly against other major currencies due to shifting economic conditions and the current high dollar denominated debt developing countries have.
Johnson used the metaphor of a milkshake to explain the current economic situation. More specifically, he described the global economy as a big milkshake, with the US dollar (along with the US central bank) “sucking up” global liquidity through the metaphorical straw in the milkshake. As liquidity is sucked out of the system a credit crunch becomes inevitable, as countries struggle to pay back their debt to a country whose currency is rising too fast.
The theory highlights that as the global economy faces challenges such as debt burdens, economic slowdowns, pandemics, and geopolitical uncertainties, investors seek safe-haven assets in times of economic uncertainty.
The US dollar, with its deep financial markets and stable economy, is considered the safe-haven currency of the entire investment world. When investors become concerned about economic risks, they tend to flock to the US dollar for its liquidity and stability. This in turn, pushes up the value of the US dollar and leads to the depreciation of other foreign currencies.
The theory also discusses the monetary policy and interest rate differentials set by global central banks. Recently, the US central bank has pursued a much tighter monetary policy compared to other central banks, resulting in higher interest rates, reduced demand, and the possibility of a recession. As interest rates continue to rise, US assets become attractive to global investors seeking yield through government bonds. This, in turn, further pushes up the US currency, which then pushes inflation higher, leading to ever increasing interest rates and even more attractive yield for investors.
Essentially, the Dollar Milkshake Theory attempts to explain the reasoning behind the current multi-decade high inflation happening across the world and the potential fallout for countries as the US dollar continues to rise to unprecedented levels.
At this point, some readers may be thinking, isn’t a strong US dollar a good thing?
Certainly, a rising dollar has its benefits, however the true consequences of the American dollar rising ever higher is more complicated than first meets the eye. Let me explain.
Without a doubt, having a strong currency can be desirable. However, when a currency appreciates too quickly or to a level that is considered too high, it begins to negatively affect the world economy, leading to not only a currency crisis for countries who will struggle to pay back their debt, but also a full-fledged financial crisis which could potentially lead to a total shutdown of the global economy.
This happens primarily for two simple reasons. Firstly, global markets and various other central banks rely on the US dollar to be the world’s reserve currency, and when the base currency appreciates too much (or too quickly), it becomes difficult (or impossible) for countries to repay their dollar denominated debt. And secondly, companies in the US that do business abroad will eventually have to convert their revenue back to their own currency, leading to less revenue recognized on a real basis and causing significant decelerating growth.
When the US dollar rises to an extreme level, it essentially prevents a central bank, entire countries, and individual businesses from being able to set policy and conduct their business efficiently. Global trade then drops, trade invoices become smaller, and debt obligations becomes harder to meet. Entire economies quickly grind to a halt, governments begin to collapse, and countries need to be bailed out through loan forgiveness or large cash infusions.
In other words, an appreciating US currency, while good in some circumstances, can be devastating to the global economy, as countries quickly become unable to meet their obligations and businesses begin to shrink their global footprint.
Implications of the Dollar Milkshake Theory
As simple as the Dollar Milkshake Theory is, the implications of it are incredibly complex. Meaning, predicting the exact consequences of a rising US dollar on the world economy is near impossible.
However, there are some certainties we can focus on when trying to understand how this theory will affect world economies.
To make things as simple as possible, we’ve broken down the implications to 7 main topics:
- Global Financial Markets: If the Dollar Milkshake Theory holds true, it could lead to significant disruptions in global financial markets. A strengthening US dollar could result in capital outflows from other countries, particularly emerging markets, as investors seek the perceived safety and higher returns of US assets. This could trigger currency depreciation, market volatility, and financial instability in developing economies.
- Emerging Market Vulnerabilities: Emerging market economies who are heavily reliant on foreign currency borrowing may face challenges if the US dollar appreciates sharply. As their domestic currencies weaken against the US dollar, the cost of servicing their external debt denominated in foreign currencies rises, leading to debt sustainability concerns and solvency issues.
- Global Trade Imbalances: A stronger US dollar could exacerbate global trade imbalances. US exports may become relatively more expensive, potentially impacting the competitiveness of US businesses in international markets. Conversely, it may make imports cheaper for the US, leading to a larger trade deficit. This could strain trade relationships and potentially contribute to protectionist measures.
- Commodity Prices and Emerging Market Economies: Commodity-exporting countries, particularly those with currencies closely tied to commodity prices, may experience additional challenges. A stronger US dollar typically exerts downward pressure on commodity prices, reducing export revenues and potentially impacting economic growth in various countries.
- Monetary Policy Challenges: Central banks in other countries may face dilemmas in responding to a strengthening US dollar. In order to maintain currency stability, they may need to raise interest rates to counter depreciation pressures, potentially dampening economic growth. This could complicate their domestic monetary policy objectives, such as managing inflation or supporting economic recovery.
- Geopolitical Implications: The strength of the US dollar plays a crucial role in global geopolitics. A stronger US dollar can reinforce the dominance of the United States in international finance, granting it additional leverage in global affairs. It may also influence the decisions of other countries, as they need to consider the implications of a strong US dollar on their own currencies, trade balances, and economic stability.
- Impact on Multinational Corporations: Multinational corporations with extensive international operations could face both opportunities and challenges. On one hand, a stronger US dollar may enhance their profitability when purchasing raw materials from other parts of the world. On the other hand, it will lower the amount of real revenue recognized when converting foregin currency to US dollars.
It is important to recognize that the Dollar Milkshake Theory is a specific perspective, and its accuracy is subject to debate. Currency movements are influenced by numerous factors, including economic fundamentals, policy decisions, and geopolitical developments, which can be difficult to predict. Therefore, it is crucial to approach such theories with caution, consider multiple perspectives, and monitor the evolving dynamics of the global economy.
What Does the Dollar Milkshake Theory Mean for Crypto?
Why the rise of bitcoin could be the first shot in a currency revolution | CBC News
The Dollar Milkshake Theory would no doubt have a major impact on the legitimacy and value of various cryptocurrencies.
Unfortunately, it is extremely difficult to accurately predict exactly how an appreciating US dollar would affect the digital currencies.
On the one hand, crypto’s could act as a better store of value (and perhaps even regular currency) for developing countries who are struggling to repay their debt. Citizens of these emerging economies would be struggling with a slowing economy and debt ridden government. This in turn, would lead to a weakening currency. Having their savings in crypto could help preserve the value of their wealth. However, the incredible volatility and lack of structure around using cryptos to pay for every day items would present new problems that don’t currently have solutions.
The case for the Dollar Milkshake Theory being good or bad for crypto is best looked at as being equal, with both sides having valid arguments.
Crypto definitely has benefits for users who want to protect themselves from a strong US dollar when compared to their own, though it also lacks the characteristics needed for a global central currency.
As well, should crypto become the currency of choice, would inevitably lead to added regulation and policy from central governments. How this policy would affect crypto’s price and legitimacy is still largely unknown.
In short, the Dollar Milkshake Theory would most certainly affect the crypto world in countless ways. And while some would argue that crypto is the solution for a rising US dollar, digital currencies still have too much unpredictability and instability to be considered a real option.
Conclusion
The Dollar Milkshake Theory carries significant implications for the global financial system. If accurate, it suggests central banks may need to adopt more aggressive monetary policies, potentially leading to greater market volatility and exacerbating crises in emerging markets.
The theory revolves around a stronger US dollar, which consequentially leads to the potential for a sovereign debt crisis in certain parts of the world, as well as diminishing revenue from American companies who operate abroad.
The Dollar Milkshake Theory certainly has some merit to it and makes valid points regarding the current economic situation and the potential consequences of a rising American currency. In truth however, economies and currencies are influenced by an exponential amount of factors, events, scenarios, and data points, and concluding that a global financial crisis is imminent because of a strong dollar is much too simplistic in reality.
Though by understanding what the Dollar Milkshake Theory is and the potential implications and outcomes of it, can help investors correctly position their investment portfolios for the risk and volatility the Dollar Milkshake Theory is likely to bring.