What Happens to Stocks If the Dollar Crashes?

2024 has been a year of global upheavals ranging from rising tensions in the Middle East to domestic political violence. Behind the front-page headlines growing risks have come to the fore and appear to threaten the US dollar’s dominance as the reserve currency of the world.

Treasury Secretary Janet Yellen has recently noted that foreign countries are moving away from the USD due to America’s increasing debt. This raises the question of just what a dollar crash would actually mean for stocks.

The effect of the dollar on stocks is a complex one, even under normal circumstances. In the extraordinary event of a dollar collapse, the stock market is likely to react wildly. So, what exactly would happen to stocks if the dollar crashes, and just how likely is such an event?

How Does the Strength of the Dollar Effect Stocks?

Conventional thinking is that a stronger dollar puts slight downward pressure on stock prices.

This phenomenon can be attributed to two different mechanisms that exert downward pressure on share prices. The first is that international sales will be worth less once converted to dollars, resulting in lower total revenues and earnings. For example, when the dollar is unusually strong relative to the Japanese yen, sales in Japan will contribute less to a company’s top and bottom lines.

Secondly, a strong dollar means that foreign investors will be able to buy fewer shares in US companies by converting their local currencies to dollars.

At one time in history, this exerted a minimal effect on stock prices because most American stocks were owned by US residents but, as of 2019, foreign investors owned about 40% of all American corporate equities.

The reduced ability, or purchasing power, of foreign investors to buy dollar-denominated US stocks can create a meaningful drag on overall demand when the dollar is strong enough.

Even with an increasingly globalized economy, it’s still worth noting that different companies are affected by the strength of the dollar to different degrees. The more of a company’s revenue comes from international markets, the more susceptible it will likely be to the anchoring effects of a stronger dollar.

What Happens To Stocks If The Dollar Crashes?

If the dollar crashes, hyperinflation is likely to take hold and unemployment would soar as investors lose trust in the US bond market and government.

Possible causes for a dollar collapse may include a major recession or depression in the United States, a default by the US government on its sovereign debt or a prolonged period of hyperinflation. Of these, hyperinflation may be the most likely culprit, as it has been responsible for several of history’s most prominent currency crises.

A recession or depression typically causes stock prices to fall sharply as investors price in earnings contractions and a riskier macro environment. A US debt default, meanwhile, is likely create so much uncertainty that share prices would become highly volatile.

Sustained hyperinflation has the knock-on effect of massively raising the costs of doing business and likely drive down corporate earnings by extension. It’s important to note, however, that this might not lead to an immediate drop in share prices in the way that a debt default or sharp economic contraction likely would.

During Germany’s Weimar Republic hyperinflation crisis, for example, the rapidly falling value of the German mark fueled speculative investment and resulted in soaring stock prices for a period of time.

It’s also worth noting that the effects of a dollar crash are likely to domino beyond US shores. The US dollar is considered the world’s reserve currency, and as of Q1 2024, it accounted for nearly 55% of all global foreign exchange reserves.

Furthermore, foreign governments owned about $8 trillion in treasury securities at the beginning of 2024, a number which has likely only grown since. As a result, a collapse of the dollar and the accompanying devaluation of US debt instruments has the potential to drive down the prices of global stocks.

In other words, even investors who focus on foreign businesses are unlikely to escape unscathed from the effects of a dollar collapse.

So too foreign businesses that sell into the United States won’t escape the fallout. The US is the world’s largest importer, meaning that companies around the world are constantly selling their goods into the US market. A dollar collapse means revenues from the US are likely to drop precipitously as consumers adjust to radically diminished purchasing power.

Overall, any event that caused the USD to actually crash rather than simply lose strength in an ordinary manner is most likely have a deeply negative effect on both foreign and domestic stocks.

The dollar has been the default currency of the world since the end of World War II, and it is going to take a profound macroeconomic shift to unseat it. The fallout is massive risks for US companies that will more than likely send the stock market into a tailspin.

How Likely Is a Dollar Crash?

The good news is that the same forces that would make a dollar crash so disastrous also make it far less likely. The dollar’s status as the global reserve currency creates steady demand and introduces structural obstacles to a turn away from it.

With the US still accounting for about a quarter of global GDP, it’s also likely that the ubiquity of American businesses will continue to provide support for the dollar.

Another reason a dollar crash remains unlikely is the lack of a credible alternative reserve currency. For a while, the Chinese yuan appeared to be a rising competitor to the dollar. The share of the yuan in global currency reserves, however, has been falling since 2022. In large part, this trend has been due to concerns over China’s economic growth.

Some concerns about the dollar’s decline are also based on incomplete or outright incorrect facts. A good example of this is the alleged dissolution of the “petrodollar” agreement that has been making the rounds on social media recently.

Proponents of this story allege that Saudi Arabia has priced its oil in US dollars by formal agreement with the United States since 1974. The dissolution of this agreement, the case runs, would sharply cut global demand for dollars and endanger the reserve currency status.

The problem with this argument, however, is that no such deal was ever struck. Saudi Arabia accepts payment for its oil in dollars because of the USD’s stability and ease of use. While the country is increasingly considering accepting other currencies as payment, it’s unlikely to substantially reduce its reliance on US dollars.

On the whole, a dollar crash appears very unlikely at the moment. Even with US national debt reaching concerning levels, it would probably take a major unforeseen event to trigger an actual crash of the dollar. The dollar may become somewhat weaker over the coming years, but its status as the world’s default currency doesn’t seem to be in significant danger.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.