What Is the Dollar Milkshake Theory?

If you’re interested in macroeconomics, you’ve probably heard of the Dollar Milkshake Theory, which is a theory predicting a scenario in which the US dollar sharply rises in value and causes a domino effect in the global economy. 

Even though the Dollar Milkshake Theory has a pretty lighthearted name, the scenario it predicts is quite grim. In this article, we’ll explain the Dollar Milkshake Theory in simple terms and outline some of its possible consequences.

What is the Dollar Milkshake Theory?

Essentially, the Dollar Milkshake Theory predicts that the U.S. dollar will remain strong despite turmoil in global financial markets. The Dollar Milkshake Theory was coined by Brent Johnson, a United States-based investor who leads investment management firm Santiago Capital. 

This could further destabilize the global financial system, as a very strong dollar puts significant pressure on countries that have dollar-denominated debt. Under the Dollar Milkshake Theory, this instability will position the United States as a safe haven, attracting even more capital into the United States markets at the expense of the rest of the world.

The U.S. Dollar Index (DXY) is designed to measure the strength of the U.S. dollar against a basket of other major currencies. In September 2022, the DXY hit its highest levels since 2002. Even though the dollar has weakened since then, the DXY is still higher than it was at any point between 2004 and 2015.

The DXY between 1990 and now (June 2023). Orange line indicates level at the time of writing.

Why is it called the Dollar Milkshake Theory?

The name is derived from the vast liquidity created by central banks’ monetary easing policies, which Brent Johnson refers to as a “milkshake” of liquidity. Meanwhile, Johnson refers to the U.S. Federal Reserve’s policy of monetary tightening as the “straw” that will “suck up” liquidity from markets worldwide, further bolstering the US dollar’s position as the dominant global currency.

The Dollar Milkshake Theory explained

The scenario predicted by the Dollar Milkshake Theory can be broken down into several phases. 

Quantitative easing policies

The first phase of the scenario described by the Dollar Milkshake Theory is central banks adopting quantitative easing policies. Quantitative easing (QE for short) is when a central bank buys securities from the market with the goal of increasing the supply of money and reducing interest rates. 

QE policies are typically adopted when interest rates are at zero or near zero. In such a scenario, central banks no longer have the option of spurring economic growth by reducing interest rates and instead turn to QE, purchasing assets such as government bonds and mortgage-backed securities.

Expansion of global liquidity

QE policies increase the supply of money and lead to expansion of global liquidity. As the European Central Bank explains, surges in global liquidity usually lead to increasing asset prices, rising credit growth, and sometimes even heightened risk-taking behavior among investors. 

Growing demand for the US dollar

The expansion of global liquidity leads to growing demand for the US dollar thanks to the United States’ unique and dominant position in the global economy. The majority of global trade is still settled with dollars, and many countries and corporations have dollar-denominated debt. 

The value of the dollar increases

Here’s where the magic of the Dollar Milkshake Theory happens. As the U.S. Federal Reserve begins a policy of monetary tightening and raises interest rates, the value of the dollar begins to grow in relation to other currencies. With the value of the dollar rising, nations with dollar-denominated debt are under increasing pressure to service their debt.

The U.S. sucks up the liquidity milkshake

As the price of the dollar rises, other countries are forced into printing more of their own currencies to convert to dollars to pay for goods and pay off their dollar-denominated debts. This causes the value of the dollar to increase even further, and positions the United States as a safe haven for capital from all over the world. This is the part of the Dollar Milkshake Theory in which the United state “sucks up” the “liquidity milkshake” described in the previous phases.

Consequences of the Dollar Milkshake Theory scenario

While the US dollar strengthening in value might seem like a positive scenario, especially for readers from the United States, the implications of the Dollar Milkshake Theory are very negative overall. 

• Large capital flows into the U.S. markets would likely cause currency depreciation and disrupt the financial stability of developing economies. Countries that heavily rely on borrowing foreign currencies would be especially affected by a rapid rise in the value of the dollar.
• Countries that heavily rely on exporting commodities would also likely be hurt, as a rising dollar usually leads to lower commodity prices. If the Dollar Milkshake Theory does play out, the economic growth of such countries would be affected adversely.
• From the perspective of the United States, an extremely strong dollar would likely hurt the competitiveness of United States-based businesses in the international markets. This is because exports from the United States would effectively become more expensive. 

Does the Dollar Milkshake Theory have any implications for crypto?

If the Dollar Milkshake Theory plays out as predicted, there could be negative consequences for cryptocurrencies. Even the largest cryptocurrencies such as Bitcoin and Ethereum still behave like risk assets, even though they have some properties that are desirable in assets that serve as stores of value. 

In the scenario of a sovereign debt crisis predicted by the Dollar Milkshake Theory, investors would likely pull their liquidity from risk assets and park it into safer investments.

The bottom line 

The Dollar Milkshake Theory is an interesting theory to consider if you’re interested in macroeconomics and are exploring how you could adjust your portfolio to be prepared for a range of scenarios.

If you’re interested in exploring more topics about investing, make sure to check out our article highlighting the best stocks for long-term investors.