The Great Debate

-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. 

Current account imbalances, while always a potential currency negative, only weigh if international savers become less keen to fund it.  Investment decisions will be determined by other factors such as relative growth and interest rates, political stability and fiscal coherence.   A huge USD negative this year has been the widening in the budget deficit to potentially 11 percent of GDP from 4.7 percent in 2008.   This implies huge bond issuance. 

– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –

LONDON (Reuters) – An article in Britain’s Independent newspaper on Tuesday rightly attracted a lot of market attention with its provocative heading “The demise of the dollar.” While subsequent and almost co-ordinated denials from numerous capitals have taken the steam out of the story, the dollar’s role is again under scrutiny.

While the geopolitical realities of the Middle East would arguably rule out the re-pricing of oil in non-dollar currencies at this time, that may change in the future.

–James Saft is a Reuters columnist. The opinions expressed are his own.–

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.

It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.

No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.

Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.

- John Kemp is a Reuters columnist. The views expressed are his own. -

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).

As the largest buyer of U.S. Treasury securities, China can break the dollar's reserve currency status any time it wants. But it would risk large losses on the stock of U.S. debt that it has bought already. The resulting unstable stability is the foreign exchange version of the Cold War stalemate based on "mutually assured destruction".