The Great Debate UK
-Jane Foley is research director at Forex.com. The opinions expressed are her own.-
If there is one foreign exchange story that will run and run it is the one about the U.S. dollar (USD) and its future as the world’s dominant reserve currency. The discussions on this topic have at least brought some agreement, namely that there is no clear alternative and therefore there can be no quick fix change. That said, much uncertainty remains as to what can, if anything, eventually replace the dollar.
The basis for questioning the USD’s position as global reserve currency stems from its declining value and its “poor” fundamentals. The dollar index is currently trading close to where it was 14 mpnths ago, ahead of the financial crisis. At that point the USD had been on a downtrend for over two years. The widening in the U.S.’s budget deficit this year has worsened the fundamental backdrop and drawn attention to its “twin deficits”. This has made creditor nations nervous.
So, how bad are these fundamentals?
The U.S. current account deficit this year has actually improved. However, once the U.S. recovery gets underway, many expect to see the current account widen again. Textbooks suggest that a current account deficit should lead to a downward adjustment in the currency which will help address the imbalance. This is not always the case. Australia presently has a current account deficit of around 4.5 percent of GDP and the effective Australian exchange rate has rallied by 27 percent since January 1, 2009.
from The Great Debate:
When the U.S. dollar ultimately loses its status as the world's premier reserve currency it will be painful for all involved, almost certainly disorganized, and very possibly a very good thing.
World Bank President Robert Zoellick outlined the risks to the dollar's status in a speech in Washington on Monday.
Judging from the draft communique of the G8 leaders meeting in L'Aquila, no one is in a particular hurry to talk about ending the domination of the dollar in world currency reserves. Our correspondents at the Italian summit report that the debate being pushed by China and others is likely to be played down.
But the genie is out of the bottle. Beforehand, Beijing floated the idea of alternative to the dollar. Russia and Brazil weighed in with some thoughts. The United Nations also acknowledged earlier this year the desire of some countries for a "more efficient reserve system" in a series of proposals for global financial reform.
Reports that China has asked for a discussion about reserve currencies at next week’s expanded Group of Eight summit in Italy has added to confusion about whether the country wants to dethrone the dollar from its status as the world’s sole reserve currency. But the very fact the issue has been pushed onto the agenda suggests that a fundamental shift is underway.
Given the U.S. government’s enormous borrowing requirements over the next decade to cover the bank bailout, fiscal stimulus and deficits in Social Security and Medicare, the dollar’s reserve status depends on emerging markets’ continued willingness to accumulate U.S. liabilities rather than switching to other stores of value, such as the euro or the IMF’s Special Drawing Right (SDR).