QUESTIONING the dollar’s status as a global reserve currency has become almost de rigueur in the past few weeks. In fact, it has been an ongoing discussion for some months now. It was discussed at the G20 meeting in Pittsburgh at the end of September and then a news report last week suggested that the Gulf States along with China, France, and Russia were plotting to end the pricing of oil in dollars.
While the currency markets quickly dismissed speculation of a dollar plot, it certainly caught the mood of the market, which was at the time – and remains so today – very dollar negative.
Since late April, the US dollar has fallen 13 per cent against the euro, and 4 per cent of this drop has occurred in the last six weeks. It now stands at a 14-month low against a trade-weighted currency basket. The dollar has been underpinned to a certain extent by its perceived safe haven status in an uncertain and risky economic environment. Against the Australian dollar, which has done well from rising commodity prices, Chinese growth and good fundamentals, the US dollar has plummeted 8 per cent since the start of September and almost 23 per cent over the past six months.
But while there has been renewed speculation about the end of the US dollar as the means for pricing oil, this is not the primary reason why the dollar has weakened and, according to Julian Jessop at Capital Economics, “the re-pricing of oil in some unit other than the dollar would, on its own, have no direct effect on the value of the US currency”.
Should oil be re-priced either into euros or a basket of currencies, Jessop says that if payment continued to be accepted in dollars, then this would make no difference. Even if the currency in which trade is actually conducted also changes, with the result that fewer dollars are used to purchase oil, Jessop believes that the effect of this on the US dollar would depend on what the recipients of these other currencies do with the money.
SWAP THE PROCEEDS
“At the moment, oil producers paid in dollars already swap some of the proceeds into other currencies. In future, they might be paid in other currencies and swap some of the proceeds back into the dollar,” he explains.
Equally, the large scale of the reserves held in US dollars by countries such as China will mean that such a switch away from the dollar as the world’s primary currency will not happen overnight.
The question of reserve currency status has certainly exacerbated the recent weakness of the dollar, but other factors will keep the dollar weak for now. Firstly, the market doesn’t think the Federal Reserve will raise rates until the second quarter of 2010, and has priced this in. Others believe it may take longer. The minutes of the most recent Fed meeting will be released later today – the initial statement from the meeting caused a sharp sell-off in the buck, so we may see more of the same.
Secondly, the need to reduce the large current account deficit that has been run for many years would suggest a necessary weakening in the dollar. These issues, among many others that drive the dollar, are both underpinning its weakness and are expected to do so until a recovery and a rebalancing of the current account are well underway.