Weakening of Dollar: Has the King lost its crown?

The United States of America (USA) has been the biggest controller of the global economy
and is the big brother even today and would perhaps be in the near future also. What
differentiates the past and the present is the emergence of the other rapidly growing
economies, like China, Japan, Russia and India, which pose a considerable challenge to the
US. The US has been the market leader for ages and hence, it would be inaccurate to say that
the King has lost its crown just because the dollar has started weakening. It is just that the US
now faces competition which perhaps was missing all this while. It is like realizing the
importance of something you have, when you are just about to lose it.
The US dollar has dictated the global market and has been the deciding factor in the relative
rise and decline of the other currencies. Even today, when the US and the entire world are hit
by the economic recession, US being one of the worst hit nations, we still compare the
strength of our currencies with the US dollar. This clearly indicates that the ‘King’ is still
going strong, just that; there are ‘heirs’ in preparation. This is an alarming situation for the
King but an opportunity for all others to make the best of this time period.
As in economics and physics, which mention that equilibrium is not a permanent state and
there co-exist the highs and lows, so is the case here. What is at the peak cannot remain there
for eternity unless you have perfect control over all the external variables. Being a leader is
one thing and being an absolute controller is another.
We can understand the position of the US dollar in a different way, if we establish the relative
state of the other currencies with respect to the US dollar. Let’s consider the Euro vis-à-vis
the USD as an example. As per industry experts, rectangular pattern breakout happened in the
EUR vs. USD at 1.43 levels and this is the critical breakout for US dollar which will lead to
long term depreciation against Euro. The US GDP published in the last week of July 2009,
showed that the GDP contracted by 1% for Q2 2009; indicating that the recession is over and
Q3 will be stabilization coupled with marginal recovery of US economy. Based upon this
upside breakout, US dollar will depreciate gradually to 1.64 against Euro for the long term; it
is likely to breach the resistance levels as it is not strong enough.
As global economic recovery, the attractiveness of the US dollar is diminishing and the
investors are seeking the alternative investment like equities and commodities which would
yield higher returns than the US dollar. This will result in diversification of the investment
from US dollar to equity and commodity market. As the depreciation of US dollar is
anticipated, the cash inflow (i.e. receipts, receivables, etc) of companies should be in terms of
Euro and cash outflow (i.e. payments, payables etc) must be in term of US dollar in order to
safe guard their profit margin and also to maintain earnings.
Another report, by the Pacific Investment Management Co. mentioned that, the dollar will
weaken as the U.S. pumps “massive” amounts of money into the economy. The dollar will
drop the most against emerging-market counterparts. The greenback is losing its status as the
world’s reserve currency. One of the portfolio managers of the company said, “The massive
amounts of U.S. dollar liquidity produced in response to the crisis” have helped reduce
demand for the currency. The Dollar Index, which tracks the greenback against a basket of
currencies, touched 78.823 on Aug 19, 2009, the lowest that week. It has fallen 12 percent
from this year’s high in March as U.S. authorities pledged $12.8 trillion to combat the
recession. China, the world’s largest holder of foreign-currency reserves, and Russia have
both called for a new global currency to replace the dollar as the dominant place to store
reserves.
“While we have not yet reached the point where a new global reserve currency will arise, we
are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of
a single viable alternative,” was the view expressed by experts.
The dollar as a percentage of global central banks’ foreign reserves increased to 65 percent in
the first three months of this year, from 64.1 percent in the previous quarter, according to the
International Monetary Fund. Its share has remained around 65 percent through the last five
years, after falling from 72.7 percent in 2001.
The U.S. government boosted spending and the Federal Reserve bought bonds to revive
credit markets that seized up after financial companies posted $1.6 trillion in write downs and
losses, raising concern there is an oversupply of greenbacks. The currency rose 0.1 percent to
$1.4118 per euro as of Aug 19, 2009. The Dollar Index is down about 2.8 percent this year,
after a 6 percent gain in 2008.
Asian currencies stand to benefit as the region’s economy grows and the dollar’s allure fades,
said Singapore-based head of Asian investments at Western Asset Management Co.
Billionaire Warren Buffett wrote in a New York Times that the dollar is under threat from the
“monetary medicine” that has been pumped into the financial system. “Enormous dosages of
monetary medicine continue to be administered and, before long, we will need to deal with
their side effects,” Buffett, wrote.
There is no viable immediate alternative to the U.S. dollar for now as the euro region lacks a
political union while Japan’s economic weakness makes it impossible to consider the yen for
such a role. The currencies of emerging states such as China can’t play a reserve role as long
as they are subject to capital controls, which restrict international traders to using non-
deliverable forwards. With the above facts, it is understandable though the US dollar has been
on a decline; there is no near future possibility of the King losing his crown, but the King
needs to ensure that he wears it tight enough!