Viewpoint: Pension funds must brace for potential US currency compromise

Next May, the term of Jay Powell, president of the US Federal Reserve since 2018, will end. In April 2025, Donald Trump declared on his mouthpiece Truth Social that “Powell’s termination cannot come fast enough!”. He has repeated his feelings often enough that we may assume that Powell will not return at the end of his term and that the next chairman will be more compliant with Trump’s wishes, which can be summed up with “damn the inflation, full speed ahead” (with apologies to admiral Farragut), except that inflation is an easier target than a torpedo.

When put into the context of Trump’s behaviour, the argument over the administrative interest rate and the state of the US economy, the departure of the chair of the Fed becomes an opportunity for the US extreme right to attack the independence of the Fed. All that is needed is to appoint a technically incapable successor who is a devout Trump adept. Any resistance within the Fed could be dealt with by dragging the opposition into court for imagined scandals. Lower ranks could simply be fired.

Such a development may be the start of a downward spiral, where, due to falling confidence on financial markets and increasing inflation expectations, US dollar holdings are liquidated at prices spiralling downward until they can no longer be sold at an acceptable price, where the cumulative current account deficits of the US become a major issue. At that point, the US dollar will no longer be a reserve currency.

The above scenario is not unlikely at all, but it is far too often shrugged off with empty arguments amounting to “there is no alternative” or “the US is too big to fail”. Once the loss of confidence starts, it will be too late to react. Pension funds, swimming in US dollar-denominated assets, will need to plan ahead and position themselves before push comes to shove. The role models, already trying to diminish their US dollar dependency, are the central banks of China and Russia. A better forward indicator is the central bank of India. India has no shortage of well-trained financial professionals, and it has no strong ties to the US, except perhaps in generic medicine. It is therefore relatively free to act early.

Would another reserve currency arise? At the moment, it doesn’t seem likely. There is no other single currency that can generate the amount of trust the US dollar still enjoys and a market capacity close to that of the US. However, is there a need for a single reserve currency? Central bank reserves can be in any trusted and liquid currency. Units of account like the SDR have proven that a basket of currencies can work. More challenging, but potentially more powerful, is an agreement between large and trusted economic players to maintain certain indicators of stability (for example, inflation and indebtedness) within an agreed bandwidth. The currency of signatories could be considered together as worthy of contributing to central banks’ reserves.

Meanwhile, what’s a pension fund to do?

First and foremost, thinking through the issue and formulating a credible plan is necessary. That plan should take into account currencies pegged to the US dollar, such as the Saudi riyal and economies heavily dependent on the US, such as Canada. Even in the worst of cases, there is much value in the US economy. This means that investments in companies that are not dependent on imports and US real estate are relatively safe. The currency risk probably needs to be hedged. The equity and bond portfolios can be tilted towards low import US companies. The main risk would be in US government bonds and investments in companies that are heavily dependent on imports. In addition, companies selling on US dollar-denominated markets, such as financials, airplane constructors and oil companies would be subject to the risk of their markets becoming chaotic until a solution has become accepted.

Peter Kraneveld is an international pensions adviser at Prime BV