“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
– John Maynard Keynes, The Economic Consequences of the Peace, 1919
Valéry Giscard d’Estaing, the former French Finance Minister, is said to have called it the “exorbitant privilege” — France’s polite euphemism for the structural advantage the United States has enjoyed since Bretton Woods: the ability to run persistent current account deficits, finance them in its own currency, and watch the world absorb the resulting dollar-denominated debt as a safe haven rather than a liability. For decades, this arrangement has functioned as a one-way subsidy to U.S. asset prices. Foreign capital poured into Treasuries and S&P 500 constituents not purely on their merits, but because the dollar was the water everything else swam in.
That arrangement is showing cracks. And if history is any guide, the asset allocation implications are considerable.
After reaching approximately 110 on the DXY index in January 2025 — its highest level since 2022 — the U.S. dollar lost roughly 10.7% of its value against the basket of major currencies by mid-year, the steepest annual decline in three decades and the worst first-half performance in more than 50 years. As of this writing, the DXY remains well below its January peak. More importantly, this weakness is arriving alongside something unusual: a simultaneous decline in both U.S. equities and U.S. Treasuries. Normally these move in opposite directions — that’s the whole logic of the 60/40 portfolio. When they fall together, it means the diversification assumption embedded in most institutional portfolios is failing. It also means foreign holders of dollar-denominated assets are experiencing a double loss: the asset itself, plus the currency it’s priced in. That is a different kind of pain, and it changes behavior.
WHY THIS TIME MAY BE STRUCTURALLY DIFFERENT
Dollar weakness is not unusual. It goes through cycles. The late 1970s, 1985–1987, 2002–2008 — each produced meaningful multi-year declines, with the largest single-cycle drop occurring in the 1985–1987 period, when the dollar shed approximately 40% against a basket of major currencies following the Plaza Accord. What’s different now is the policy backdrop against which the current episode is occurring.
Prior episodes of dollar weakness happened within a context where the U.S. maintained its credibility as a rules-based counterparty: predictable trade policy, independent institutions, a Treasury that broadly respected its implicit obligations to foreign holders of its debt. That credibility was the foundation of the privilege d’Estaing identified. It is precisely that credibility — not trade imbalances, rates, or another facet of the economy alone — that makes a reserve currency work.
The current environment introduces uncertainty into that foundation in a way the last several decades have not. Trade policy has become explicitly transactional, abandoning decades of rules-based multilateral engagement in favor of country-by-country negotiations over bilateral trade balances. The Treasury market experienced bouts of dysfunction in April 2025 — a rare simultaneous selloff in equities, bonds, and the dollar that had previously appeared only during acute crises like March 2020 and the 2008 Global Financial Crisis; in just five trading sessions, the 10-year Treasury yield surged nearly 50 basis points, rattling markets enough that the administration announced a 90-day tariff pause. And central bank independence has been publicly questioned in a manner unprecedented in the modern era. None of this is necessarily disqualifying on its own. Together, they raise a question that sophisticated allocators around the world should be asking: is dollar-denominated risk being priced correctly?
The data suggest the answer is increasingly no.
According to Bank of America analysis, foreign central banks became net sellers of Treasuries beginning in March 2025, with custody holdings at the New York Fed falling by $48 billion from late March onward. What makes this particularly notable is that these sales are occurring during a period of dollar weakness — the opposite of when reserve managers typically reduce dollar holdings. “The sales are not happening to defend currencies or to rebalance.” Gold, historically the reserve asset of last resort, has risen sharply. Allocation diversification away from U.S. equities by sovereign wealth funds and large foreign pension managers has been reported in every major financial center. These are slow-moving flows, but they are directional.
THE HISTORICAL PRECEDENT
The 1985 Plaza Accord(1) is instructive, though imperfectly analogous. Then, as now, the dollar had appreciated dramatically against major trading partners — roughly 50% from 1980 to its February 1985 peak — creating significant current account imbalances. The G5 nations coordinated a managed depreciation. The dollar subsequently fell approximately 40% on a broad major-currency basis by 1987, including a roughly 50% decline against the yen and deutsche mark specifically.
The asset allocation aftermath was significant. International equities — particularly Japanese and European — dramatically outperformed U.S. markets during this period in dollar terms, as local-currency returns were amplified by favorable exchange-rate translation; in the mid-1980s, MSCI EAFE outperformance versus U.S. equities reached its highest magnitude in decades precisely because of dollar weakness. We are already seeing a preview of this dynamic: in the first half of 2025, the MSCI World ex-USA Index returned 19.5% compared to the S&P 500’s 6.2% — a gap driven substantially by currency translation. Commodities priced in dollars rose substantially in the post-Plaza period as well, benefiting from the inverse relationship between the dollar and dollar-denominated hard assets. It is not 1985. But the structural setup — overvalued dollar, large trade imbalances, foreign creditor fatigue, policy-driven depreciation pressure — is concerningly reminiscent.
The more ominous historical parallel is the 1970s.(2) That decade produced the worst sustained period of real returns for a traditional U.S. 60/40 portfolio in modern history — the S&P 500 lost roughly 2% per year in real terms across the 1973–1982 period, while the 60/40 portfolio struggled mightily as bonds also lost purchasing power. It also produced extraordinary returns for commodities and real assets: gold rose from approximately $35 per ounce to roughly $850 — a nominal gain exceeding 2,000% — as the dollar and U.S. geopolitical credibility came under simultaneous pressure. Any strategy that could rotate toward strength and away from weakness captured the opportunities that decade produced, because the weakness was not distributed evenly. It rarely is.
WHAT THIS MEANS FOR PORTFOLIO CONSTRUCTION
If we are indeed entering a period of sustained, policy-driven dollar weakness — even a gradual one — the implications for a U.S.-centric buy-and-hold portfolio are underappreciated by most investors.
First, the correlation assumption breaks down. As we are seeing now, the traditional negative correlation between U.S. equities and Treasuries is unreliable when the dollar itself is under pressure. Both assets are denominated in the same currency, and if that currency is the risk, holding both provides no diversification against the central threat.
Second, international diversification re-emerges as outperformance, not just exposure. In a dollar-strengthening environment — which is what the 2010s largely were — holding international equities was a return drag even when local-currency performance was fine. A dollar-weakening environment reverses this precisely. The same local-currency return, translated back at a more favorable rate, becomes significantly higher in dollar terms. European equities, Japanese equities, emerging markets with commodity exposure — all benefit mechanically from dollar weakness on top of whatever their local fundamentals produce.
Third, real assets deserve a more prominent role. Gold and commodities have historically been the clearest beneficiaries of dollar depreciation cycles. This is not a prediction about gold prices specifically — it is a structural observation about how capital flows when the denomination of the global reserve asset is in question.
The portfolio that is built for a single-regime world — U.S. exceptionalism, strong dollar, declining rates — is the portfolio that worked extraordinarily well for the last fifteen years. It is not necessarily the portfolio for the next fifteen. Identifying regime shifts is notoriously difficult in real time. But ignoring the evidence that one may be underway is its own kind of risk.
THE INVESTOR’S RESPONSIBILITY
There is a temptation, in uncertain environments, to reach for the familiar. The familiar, for most U.S. investors and their advisers, is domestic equities and fixed income. The mental accounting is comfortable; the benchmarks are well-understood; the career risk of deviation feels higher than the portfolio risk of staying put.
But as I wrote about the yen carry trade unwind previously — it is the responsibility of professional investors and stewards of capital to remain steadfast students of history and its cyclical nature. Crowded trades, extended regimes, and structural assumptions that have never been tested all carry the same risk: when they reverse, the reversal is violent precisely because positioning is so one-sided.
A quote from Bridgewater’s Co-CIO, Bob Prince, seems relevant here, especially for US investors (and their particularly strong home country bias):
“Most institutional portfolios are badly out of balance. The returns of most institutional portfolios are 90+% driven by the return of equities, exposing them to a single adverse event which could last for decades, a poor performing equity market…. Not balancing the portfolio is so risky as to be imprudent.”
The dollar’s reserve status is not going away. But the unquestioned primacy of U.S. dollar assets as the default global allocation may be shifting. The investors who are positioned to benefit from that shift — rather than simply endure it — will be those who recognized the regime change before it became consensus.
That recognition starts with asking an uncomfortable question: how will my portfolio fare if the next decade looks less like 2010–2020, and more like 1973–1983?
_______________
Footnotes:
1. The Plaza Accord (1985): On September 22, 1985, the finance ministers and central bank governors of the G5 nations — the United States, Japan, West Germany, France, and the United Kingdom — met at the Plaza Hotel in New York City and agreed to coordinate intervention in currency markets to depreciate the U.S. dollar. The accord came after the dollar had appreciated roughly 50% against major currencies from 1980 to its February 1985 peak, producing large U.S. trade deficits and mounting domestic protectionist pressure. The intervention was immediately effective: the dollar subsequently fell approximately 40% on a broad basis by 1987, and roughly 50% against the yen and deutsche mark specifically.
2. The 1970s — The Worst Decade for 60/40 Portfolios in Modern History: The period from roughly 1973 to 1982 is the most severe stress test a traditional U.S. equity/bond portfolio has faced in the post-war era. A combination of oil shocks, the end of Bretton Woods, wage-price spirals, and deteriorating U.S. geopolitical credibility produced a decade of negative real returns in both stocks and bonds simultaneously. The S&P 500 delivered approximately –2% per year after inflation (real) from 1973 to 1982. Long-term bonds suffered as well, as rising interest rates eroded their value. The assets that thrived were those that benefited from dollar weakness and inflation: gold rose from roughly $35 to $850 per ounce (more than 2,000%) and broad commodities surged. This was a was a macro-rotation environment, where the ability to move across asset classes and geographies determined outcomes.