With the Dollar index climbing to over 108 in July, the highest level it has been since 20 years, it is a good time to look at the Dollar Milkshake Theory, wich offers a plausible explanation for this trend and its implications.

The Dollar Milkshake Theory was popularized by Brent Johnson, head of Santiago Capital. If you want to listen to a good podcast in which he explains his views around the theory, you can do so here.

His argument is that all fiat currencies always have the tendency to be expanded. Whenever there is any crisis, or event, where spending slows down and liquidity is tightening, central banks step in and provide stimulus in the form of creating new money. During the COVID-19 Pandemic, the injections have been massively increased to a totally new level. With the whole world working all together and inducing a massive amount of newly created money into the system, asset prices as well as debt levels have been pushed to unsustainable heights. Furthermore, always when there has been any economic slowdown and turmoil over the past 25 years, the dollar has been strengthening against other currencies.

The main reason for this phenomena is that the dollar is the global reserve currency. Thus, in times when the economic condition worsens, there is turbulence in the markets and credit gets tight, the demand for the dollar tends to increase. It is the most liquid asset and most liabilities are denominated in dollars — not only in the US, but arguably to an even larger extent abroad, through Eurodollar settled debt contracts.

In contrast, other major currencies — like the Euro, Japanese Yen, or the Chinese Yuan — might have a strong domestic demand, but internationally, they are just not used and demanded that much, at least not to a comparable extend.

Thus, if any other central bank makes monetary policy, it mainly affects only the country in question. On the other hand, if the Federal Reserve makes monetary decisions about the fed funds rate or balance sheet expansions — or reductions — it affects the whole world.

This has led to an enormous increase in dollar denominated debts across the globe. The interest, that has to be paid on these massive debts, creates a strong constant demand for US dollars.

At some point, this upward trending debt-to-GDP increase has to end in a major sovereign debt crisis.

To summarize the theory that he puts forward: A culmination in debt burdens and monetary expansion will kick off the following sequence of events:

• Sovereign & General Debt Crisis
  → Money will leave bonds (globally).
  → Instead it will go into the U.S. equity market, hence, the U.S. is sucking up increasing amounts of capital.
  → Other entities find it harder and harder to get dollars.→ Their dollar denominated debt burdens rise and become unserviceable.
  → Defaults start to occur.
  → Once this liquidity crisis starts, it sets into effect a negative feedback loop.
• The ultimate result is that all the artificial value, that was created by monetary expansion, is finally gonna be sucked up by the US market and the USD.

Therefore, Johnson believes that the cash-flows are increasingly going to leave other currencies and go into the dollar over the coming years. Hence, the dollar index will go significantly higher. Not in a straight line, but with some pullbacks on the way up.

What we are currently seeing with countries, such as Sri Lanka not being able to service their US denominated debt, Argentine and Turkey on the verge of hyperinflation and a major currency like the Japanese Yen, depreciating more than 20% in a few months, are all aspects of the Dollar Milkshake Theory set in motion.

Consequently, according to Brent Johnson’s Milkshake thesis, a good investment strategy (at the moment) would be buying dollars, blue chip US equities, productive land (in America), gold — and maybe a milkshake. 🫗😅

Despite near-term appreciation in US assets and dollars, Johnson believes that the story ends badly for everybody. The US only outperforms on a relative basis in comparison to all other fiat currencies in the coming months and years. In the long run, it is also doomed to depreciate substantially.

I agree with many aspects of this theory. I also think that our current monetary experiment of running the entire global economy on a system of pure freely fluctuating fiat currencies will collapse. This experiment was started in 1971, when Nixon closed the gold window. It is flawed for several reasons and will fail terribly. Here is a website with charts that I highly recommend everyone to check out. It painstakingly illustrates, what a centrally planned fiat currency system does to all aspects of an economy.

I further agree, that the US dollar is probably the last domino to tumble.
Although I am not so sure that most value has to necessarily flow towards US equities for this to be true.

However, as readers who are familiar with my base thesis already know, I think that there is one asset that has an even bigger straw and will ultimately be the one swallowing it all up.

I feel like having a milkshake now. 😁