Don’t cry for the dollar, yet

September 18, 2009

agnes1– Agnes T. Crane is a Reuters columnist. The views expressed are her own –

It looks bad for the dollar, but looks can be deceiving.

Its sharp decline in the last week has pushed the euro to its highest level in a year and reignited fears that there’s only one place for the dollar to go, and that’s down.

Rhetoric from influential investors like Warren Buffett as well as big foreign buyers of U.S. debt like China and Russia has fed that sense of doom.

Then there’s the yen-like role of the dollar as the funding currency, which is casting a pall over the buck since the longer the Fed keeps a lid on interest rates, the longer the pressure stays on the currency.

Yet the dollar is still the No. 1 currency stashed in reserves around the world, by a long shot. International Monetary Fund data showed the dollar accounting for 65 percent of total allocated reserves in the first quarter.

That means there’s only so far you can push the currency before the self-interest of the world’s savers kicks in to support the buck.

First a little perspective. The dollar’s decline this year mirrors the rise in risky assets like U.S. junk-rated corporate debt that have returned to valuations seen before Lehman Brother’s implosion. Just as credit markets shut down and money poured into safe-haven U.S. Treasuries, the dollar soared as currency investors viewed it as a place to hunker down until the storm passes.

It may still be cloudy, but investors have been confident enough to venture back into riskier territory like emerging markets, which are booming.

That’s meant less money for U.S. assets. Recent data from the U.S. Treasury confirmed as much when it showed net foreign capital outflows of $97.5 billion in July, up from the exit of $56.8 billion in the previous month.

The Fed’s zero-bound interest rate policy has also turned the dollar into a funding currency, where investors borrow in the low yielding dollar and invest in nations that offer juicier returns.

“The dollar is selling off because we have low interest rates. That’s a macro fact,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

Yet, unlike the Japanese yen, which also served as a funding currency earlier this decade, the dollar, or rather dollar-denominated assets, continues to be sought after by nations with big reserves like China and Japan.

Brown Bothers Harriman notes that China snapped up $21.5 billion of such assets in July while Japan added $19.25 billion. Russia and Brazil, which are also sitting on stockpiles of reserves, trimmed their holdings by a relatively small amount.

This is significant. Earlier this year, China and Russia spooked currency markets when they began talking about the need for an alternative to the dollar for the world’s currency reserves.

Such an alternative would help savers like China better protect the value of their assets should the dollar fall out of favor, as it is now. Yet it could take years if not decades to implement.

That means the dollar is still the only game in town, rightly or wrongly, which should provide some comfort to those fearing the worst — a dollar in freefall without a net.

26 comments

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The dollar has been there before and done that before, and made a comeback strong enough to turn the tide in WWII, including fund most of the Allied nations and their armies. And then forgive there debts, plus finance the rebuilding of many of the nations of Europe and Asia whether ally or enemy.This is a speedbump in a long and winding road.You might notice that very few of the nations who speak of replacing our currency even suggest that their own might be a suitable replacement.

Posted by Sternberg | Report as abusive

Cry for the dollar? Not likely.Now more than ever before, it’s only money.

Posted by The Bell | Report as abusive

Gil: “Realignment of exchange rates in currency= balancing of global current accounts”. Short and sweet, maybe we could add ‘financial and capital accounts’ too.Unless I missed something, a currency is simply a commodity or inventory, its price subject to supply and demand.There are in fact overtures of replacing the $ – the IMF ‘One Reserve Currency’ and the Chinese, as immature as their economy is. The former will drive conspiracy theorists nuts, so would the latter. The middle way would be to consolidate regional timezoned currencies, into, say six. Due to self interests and the all the complexities involving central banks, diplomacy and treaties, that will carry us through to beyond 2020, unless everybody decides to sell their dollars in one go.Its like the global warming argument, if Yellowstone blows its top, it will be global freezing.

Posted by Casper | Report as abusive

http://www.businessday.co.za/Articles/Co ntent.aspx?id=82105:“If they can find a serious increase in consumer demand, that would help. We don’t really understand why the Chinese savings rate is so high, but it’s probably due to” large precautionary savings. He warned that any decision by China to diversify its currency reserves away from the dollar would “hurt Europe and Japan the most”.Explain that to me.

Posted by Casper Lab | Report as abusive

Hey, Reuters News Service Editors-Is it spelled Brown Bothers Harriman? Someone forgot the ‘r’in Brothers while they were busy trying to resuscitate the dollar.

Eventually, we will get an entirely new currency: the Amero dollar. This will happen when Mexico, the United States, and Canada become one country. It will preclude the New World Order. Don’t believe me? Then read the NAFTA report at your local library.

Posted by Mufaso | Report as abusive