While many long-term holders of international equities have been celebrating the long-awaited payoff to diversification, the outperformance of international equities so far in 2025 may not be as straightforward as it seems. Figure 1 shows the year-to-date returns (through 9/30/2025) of MSCI EAFE Unhedged (international equity index), MSCI EAFE Hedged, and the S&P 500.
Figure 1
Source: Bloomberg, AAFMAA Wealth Management & Trust LLC
Notice in Figure 1 that the year-to-date returns to MSCI EAFE Hedged (15.94%) and the S&P 500 (14.81%) are not significantly different, while the returns to MSCI EAFE Unhedged (25.83%) are significantly higher. What this tells us is that the outperformance of international equities has been more driven by currency appreciation relative to the US Dollar rather than stronger local returns of international equities. Indeed, if we look at the US Dollar Index though September 30, 2025, we see that the US Dollar has fallen 9.87% which comprises 90% of the difference in performance between international equities (EAFE Unhedged) and the S&P 500. While a 9.87% fall in the US Dollar is not outside the average annualized volatility range for the US Dollar, what is concerning is that the weakness in the US Dollar is happening concurrently with other significant asset moves. These significant shifts are collectively being referred to as part of the “debasement trade.”
The debasement trade refers to investors’ shift into hard assets, e.g. gold, as a hedge against the erosion of fiat currency values. In recent years, the focus has been on reducing exposure to US Dollar and Treasuries. Specifically, persistent government deficits, rising debt, stubborn inflation, geopolitical instability, and declining trust in central bank independence have been the broad categories driving the debasement trade.
While the term “debasement trade” has only become part of the mainstream financial conversation in 2025, the trade itself has been taking place since 2015 or earlier. The Bank of China has been steadily increasing its gold reserves as part of a broader strategy to diversify away from US Dollar assets. Figure 2 shows the steadily increasing levels of Bank of China gold reserves over the past 25 years. As of 2025, Bank of China gold reserves are more than five times the level held in 2000.
Figure 2
Source: World Gold Council, AAFMAA Wealth Management & Trust LLC
The Bank of China hasn’t been the only central bank diversifying reserves away from fiat currencies. In 2022, following Russia’s invasion of Ukraine, western nations froze $322 billion of Russian foreign exchange reserves. These reserves were largely in US Dollars, Euros, and other western currencies. In the aftermath, Russia had to rely heavily on its domestic gold reserves. This incident was a wake-up call for many emerging market countries who realized that foreign exchange reserves could be easily weaponized. Gold’s role as a politically safe asset with no counterparty risk sparked a wave of emerging central bank reserve diversification into gold. China, India, Turkey, Brazil and Poland began significantly accelerating gold purchases in the aftermath. The National Bank of Poland added 90 tonnes of gold in 2024 alone, leading all central banks in gold purchases last year.
At the beginning of 2025, the debasement trade was largely a de-dollarization story. Emerging market central banks were continuing to diversify reserves out of US Dollars and into gold. Globally, investors were overweight the US Dollar largely due to years of outperformance of US equities. This led to reduced buying as well as hedging of US Dollar exposure which accounted for significant US Dollar weakness during the first quarter. The reserve diversification and hedging of overweight US Dollar positions were not headline news at the time as reserve diversification was an established trend and the selling of the US Dollar after strong US asset returns in 2023 and 2024 seemed logical. It was not until after April 2nd, “Liberation Day”, that the debasement trade started to be discussed more widely. Concerns about political instability, unsustainable government spending, and dislocations in the US Treasury market led to a significant step up in gold prices to the $3300 level (Figure 3), where gold range traded until more recent developments.
Figure 3
Source: Bloomberg, AAFMAA Wealth Management & Trust LLC
Unfortunately, the US is not the only country suffering from unsustainable fiscal policy, high levels of debt, and declining confidence in government bond markets. Government debt in the US, UK, Europe, and Japan is at historically high levels. Recently, political instability and concerns about fiscal policy in Japan and France have further underpinned the debasement trade. Although not October headlines, similar concerns in the UK and Italy have contributed to the trade in 2025.
In October, Sanae Takaichi became Japan’s prime minister. Her pro-stimulus stance has raised concerns about looser fiscal discipline, prompting investors to demand higher yields on long-term Japanese Government Bonds (JGBs). The Bank of Japan also began exiting its Yield Curve Control program and reduced bond purchases, ending decades of loose monetary policy. This shift led to volatility in long-dated JGBs. At the same time, Japan’s core inflation rate hit 3.3% year-over-year. Foreign purchases of JGBs have declined significantly. There is concern that Japanese bond shocks could ripple into other developed bond markets and push developed market bond yields higher globally. Figure 4 shows the volatility and significant rise in JGB yields in 2025.
Figure 4
Source: Bloomberg, AAFMAA Wealth Management & Trust LLC
In addition, France has experienced a wave of political instability in 2025. Prime Minister Sébastien Lecornu resigned earlier this month, just 14 hours after naming a new cabinet. France has cycled through multiple prime ministers in recent years, with each struggling to implement austerity or fiscal reforms. Political fragmentation has made it nearly impossible to pass meaningful budget legislation. France’s public debt has surged to 113% of GDP. French bond spreads have widened to 0.80% over German Bunds. With slowing economic growth and rising social spending pressures, fiscal consolidation looks unlikely.
The events in Japan and France combined with the US government shutdown in October coincided with another significant move higher in gold. If we refer back to Figure 3, we see that gold is up 50% year-to-date and more than 15% since September 1st. While a backdrop of easier US monetary policy, declining real rates, and structural changes in global reserve holdings is a supportive environment for gold, it is hard to reconcile the move with the level of US economic growth and the S&P 500 posting daily record highs. The price moves year-to-date suggest there are additional forces at play.
World Gold Council data for the second quarter of 2025 suggest that central banks bought 900 tonnes of gold in the first half of the year. This was less gold than in the preceding two quarters in terms of tonnes, but net purchases of around $18 billion were near recent quarterly averages in US Dollar terms. Globally, gold now comprises 24% of foreign exchange reserves and for the first time since 1996, central banks hold more gold than US treasuries. In order to understand the future impact of this structural shift into gold reserves, some concept of neutral needs to be introduced. That is, when will central banks reach their target level of gold reserves. Goldman Sachs sees central banks as still underweight target levels of gold reserves and projects the current trend in official sector accumulation to continue for another three years.
In addition to the central bank buying of gold reserves, the private sector has gotten involved in the debasement trade as well. Private sector diversification into gold ETFs has been significant and as the Fed cuts rates and real rates decline, that will put further upward pressure on private purchases though gold ETFs. Additionally, the private sector has diversified into digital currency as another way of expressing the debasement trade. Bitcoin has emerged as a modern hedge against fiat currency weakness. Like gold, the Bitcoin market is significantly smaller than the treasury market and has fixed supply which allows smaller allocations to have outsized effects on the price of Bitcoin. While there is much anecdotal evidence of diversification into Bitcoin as a hedge, we are more cautious about Bitcoin as it continues to trade more like a risky asset than a hedge. Figure 5 shows the correlation between Bitcoin and NASDAQ as well as the correlation between Bitcoin and gold. Bitcoin continues to be very highly correlated with NASDAQ, especially during “risk off” periods when equity markets fall significantly.
Figure 5
Source: Bloomberg, AAFMAA Wealth Management & Trust LLC
Part of the debasement trade is being driven by a structural shift in global reserves held in gold. The pace of accumulation does not appear to be slowing in the near term. Private sector diversification into gold and other hard assets, especially in response to government instability, is also putting upward pressure on gold prices. While governments could move to tighten fiscal policy and raise interest rates aggressively which would move to stabilize inflation and underpin fiat currencies relative to gold, we do not see this as likely and expect further upward pressure on gold through 2026. treasuries. We expect this to manifest as a further reduction in the overweight US asset positions that foreign countries have built up over years. This will keep pressure on the US Dollar as well as US risk assets until we get some market stability and clarity on the steady state of US tariff policy.
Yours in trust,
Parker
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