In my humble opinion there is a significant risk that the US dollar will lose its reserve currency status. However my view is that at worst this can happen gradually over a period of time rather than in a sudden manner.
The recent debate around the reserve currency status of the US dollar must be examined in terms of different dimensions that impact this status and also from the perspective of various private and state actors who influence it.
George Soros in his March 2008 book "The Credit Crisis of 2008" predicted the end of an era and the collapse of the US dollar. He recounted that in January 2008 he went massively short on the US Dollar and long on the Indian stock market. Both the positions were losers and his firm,according to the book, "took it on the chin". Marc Faber, Jim Rogers, Peter Schiff and perhaps Stephen Schwarzman are other US dollar bears.
If any other country on earth had been in the same macro economic situation as the United States was in 2008, its currency would have been subjected to a massive speculative attack from private currency speculators. This would have begun with a tremendous build up of short positions on the currency in the forex derivatives market. The fact that the US dollar escaped a successful attack from currency speculators in 2008 does not neccessarily augur that it will indefinitely retain its unique role in international trade as well as its exorbitant previlege to run painless fiscal deficits.
In 2008 several state actors have openly indicated a policy shift in the composition of their central bank foreign exchange reserves. Iran's President Ahmedinijad made a self congratulatory speech in which he claimed that his decision to shift over from the USD to the EUR as the Iranian reserve currency was apt both from an investment perspective as well as from a political perspective. The German Foreign Minister Peer Steinbruck gave an interview in which he predicted that future forex reserves would move towards a combination of the US dollar, the Euro, the Japanese Yen and the Chinese Renminbi. Nicholas Sarkozy of France indicated that "the US Dollar is not the only currency in the world" in his statements prior to the G-20 summit. Though Japan continued to maintain strong support for USD denomination of international trade, Japan made a request to the US Treasury to issue Yen denominated debt securities to the Bank of Japan.
Given the political enmity with Venezuela's Chavez and Russia's Putin, those two countries will probably welcome any chance to ensure the demise of the US Dollar.
The only prominent supporters of the US dollar are emerging market economies like China and India. These countries are compelled to peg their currency to the US dollar since significant percentages of their population is directly dependent for their employment on a sustainable profitability of their export sectors.
Trade protectionism is another aspect which impacts the US dollar. Given Obama's recent focus on data from manufacturing and unemployment statistics in some of his comments, there is widespread speculation that the new administration is likely to pursue protectionist policies. If the level of export demand for emerging market output becomes unsustainably low due to protectionism the remaining state supporters of the US dollar reserve currency status will change their view.
If the Obama Administration does not resort to severe trade protectionism it is quite likely that 2009 will see the US dollar gradually weakening against major world currencies, rather than undergoing a sudden collapse.
However in this analysis we have to recognize that a lot depends on the relevant emerging market economies wishing to sustain employment levels in the medium term. In the longer term, it is difficult to see how or why a country like China, for instance, would want to continue the policy of accumulating US Treasury bonds in lieu of real goods.
Improved measurement of Exchange Market Pressure (EMP) - by Ila Patnaik, Joshua Felman, Ajay Shah. Exchange rates vs. exchange market pressure Changes in the exchange rate are very visible. But is the apparent c...
1 day ago