Two Reasons Why Interest Rates Will Rise

The U.S. dollar is still regarded as the reserve currency of the world. The majority of international transactions are settled in U.S. dollars and most central banks around the word hold it in their foreign exchange reserves. 

But since the Credit Crisis of 2008, and the multi-trillion-dollar printing program by the Federal Reserve, the supremacy of the U.S. dollar as the “world’s currency” has been challenged. 

The BRICS countries (Brazil, Russia, India, China, and South Africa) have agreed on starting a new development bank that will compete with the International Monetary Fund (IMF) and the World Bank. (Source: Washington Times, August 5, 2014.) Both the IMF and World Bank are “U.S. dollar”-based. 

Since the year 2000, the U.S. dollar composed about 56% of all reserves at central banks. But after the Credit Crisis, that percentage started to decline. In 2013, the greenback made up only 32.43% of all foreign exchange reserves at foreign central banks. (Source: International Monetary Fund COFER data, last accessed August 11, 2014. 

Yes, the $3.5 trillion in new money the Federal Reserve has created out of thin air has made other central banks nervous about holding U.S. dollars in their vaults. After all, if you were a foreign central bank with U.S. dollars as your reserve currency, how good would you feel to know the U.S. just printed more dollars as it needed them without any backing of gold? 

But it’s not just the money printing. It’s the massive debt the U.S. government has accumulated…currently at $17.6 trillion and soon to be $20.0 trillion. 

In the short-run, the U.S. dollar is still considered a safe haven during times of geo-political situations. But in the long-term, with the continued growth of China as a world economic power, backed by their BRICS partners, all with their own agenda, the future of the U.S. dollar as the world reserve currency comes into question. 

What does this mean for you? If you are holding American dollars, my first thought would be to diversify out of them. I’m not talking about converting all your U.S. dollars to another currency. I’m talking about taking 10% of your U.S. dollar net worth and diversifying that into something else (like gold or a stronger currency). 

Secondly, after almost 30 years of declining interest rates, I’m convinced interest rates have bottomed out and will need to start rising. 

Yes, after that $3.5 trillion in money printing, inflation will become a problem (which will push interest rates higher). But as investors stop running to the security of the U.S. dollar in times of uncertainty, as the BRICS’ effort intensifies, the U.S. will need to make owning U.S. dollars more attractive. And any currency that has a higher interest rate attached to it is more attractive. 

This article Two Reasons Why Interest Rates Will Rise was originally posted at Profit Confidential