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Death of the U.S. Dollar Somewhat Exaggerated

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Tuesday, 08 Sep 2009 12:55 PM Current | Bio | Archive

When we take China as a risk-appetite indicator, considering China’s commented moves on foreign exchange reserves diversification and further hints of an economic recovery, then everything seems to be in place for further downward pressure on the dollar and upward pressure on the euro.

However, things are not as simple as they might seem to be.

There is no doubt we see improving economic trends across the globe while, nevertheless, there are serious doubts where and when sustainable growth, which is growth generated by the private sector, will come from.

It’s certainly not the American consumer who’s going to do it. It remains to be seen whether vitalizing private demand through public spending stimulus will prove successful and sustainable.

China, too, will have to face reality in the foreseeable future and consider the daunting prospect of diminishing the role for state spending, as there are growing concerns about the limited provisions of bank lending. Remember, this was the main cause of the 22 percent fall of the Shanghai Composite Index in August, when foreign investors markedly reduced their exposure to the country’s markets.

Notwithstanding that the Shanghai Composite Index has recovered some ground this month, there are no signs of returning foreign buying. Moreover, there are indeed persistent doubts over the Chinese economic outlook.

Given the China’s dominant role in so many commodity markets, the CRB Futures Index isn’t certainly on the upswing.

We all know that China now also targets the euro in their foreign exchange reserves diversification undertakings. As far as the euro is concerned, we shouldn’t overlook the costs of fostering a recovery in the Euro-zone, as well as the quality of growth.

It was just as recently as in March that the French and German finance ministers called for a swift return to the "stability and growth pact," which is supposed to bind governments to budget deficits of less than 3 percent and total debts of less than 60 percent of GDP.

I don’t take Germany’s promises at the G20 meeting in London too seriously, and it will be wise to wait and see if the Germans, after the upcoming elections, will maintain their fiscal stimulus position. It’s not an overstatement to say there are genuine doubts over the health of non-public demand in the Euro-zone and the damage being caused by a strong euro.

It is also noticeable that the latest portfolio flow data show that there has been a marked acceleration in the outflows of capital from French, German, and Italian fixed-income markets since late last month. Until now, it is clear that increased investor risk appetite has supported the euro.

In my opinion, there are sufficient “foggy areas” supporting the rise of the euro against the dollar to evoke at least some prudence before investors taking part of the current EUR/USD upswing.

As far as the dollar’s dominance as reserve currency is concerned I would like to say that it will be the conduct of the two largest central banks of the world, the Fed and the ECB, that will be the decisive factor in determining whether the dollar will remain the world’s largest reserve currency.

They have three scenarios to choose from. First, the ECB goes soft, which is highly improbable. Second, the ECB gets tough while the Fed doesn’t. Third, the ECB gets tough, and the Fed also gets tough. Under the first and third scenarios, the dollar remains the prime global reserve currency. Under the second scenario, the euro can displace the dollar, at least in part.

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HansParisis
When we take China as a risk-appetite indicator, considering China’s commented moves on foreign exchange reserves diversification and further hints of an economic recovery, then everything seems to be in place for further downward pressure on the dollar and upward pressure...
hans,parisis,dollar
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2009-55-08
Tuesday, 08 Sep 2009 12:55 PM
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