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U.S. Dollar to Remain Strong Despite Pressures

Wednesday, 27 May 2009 10:15 AM Current | Bio | Archive

Speaking at the Seoul Digital Forum in Korea overnight, economist Nouriel Roubini gave, in my opinion, interesting comments that investors shouldn't overlook.

"We are not yet at the bottom of the United States and the global recession. … The contraction is still occurring and the recession is going to be over more toward the end of the year rather than in the middle of the year. … There is still too much optimism that a recovery is just around the corner. … U.S. economic growth is going to be below potential for at least two years. … The latest economic indicators from Korea ... suggest there is the beginning of an economic recovery, and growth (in Korea) might be already positive in the second quarter."

Roubini also said the downside risk was if advanced countries did not recover fast enough and if China's rate of growth started to slow again. He predicted China would post a 6 percent growth rate this year, which is in fact a "hard landing" for China considering it grew by 10 percent for a decade.

In his conclusion, Roubini said that a robust recovery in Korea, China, and other countries in the region would depend upon relying less on external demand and export-led growth and relying more on domestic growth.

At the same time, Guan Tao of the Chinese State Administration of Foreign Exchange (SAFE), which invests the nearly $2 trillion of China's currency reserves, writes that the global financial crisis has tarnished the U.S. dollar and will prompt reserve managers to diversify, but the currency will retain its dominant international role.

"The phrase, 'my dollar, your problem' vividly captures the capacity of the United States to exploit the current international monetary system to palm off this crisis."

However, he noted that diversification brought the risk of greater turbulence in non-USD currencies, noting: "In reserve baskets, the more currencies is not necessarily the better … (Alluding to SDRs – the IMFs Special Drawing Rights, he comments) … there are numerous technical implementation problems, so its outlook is not bright … By actively participating in and promoting reform of the international currency system, China does not want to abolish or replace the U.S. dollar. Rather, it wants to protect and realize its national interests through limited and viable reforms."

In clear English, China confirms the dollar will remain the only reserve currency, for some time to come. The problem is that there is the risk China, and others could start to diversify part of their 'reserves' into, let's say, the four major currencies the IMF uses for its SDRs, gold, and other hard, tangible, liquid assets.

In this context, it will also interesting to see what surfaces next week from the President Obama's visit to the Gulf and his meeting in Riyadh with King Abdullah.

There is no doubt that the president will seek support for the nuclear standoff with Iran and for reviving the Israeli-Palestinian peace process. That said, this visit comes coincidently at an interesting time in the currency and oil markets and revives in me some memories of former Treasury Secretary Henry Paulson's visit to the Gulf a year ago when the Saudis hinted that if America wanted more oil, it should do something to shore up the dollar.

At that time we had $130 oil and needed $1.88 to buy one euro.

Subsequent to Paulson's meetings with the Saudis, we noted a significant hardening of the language from the U.S. authorities on the issue of the U.S. dollar that included several uses of the word "intervention" while Fed Chairman Bernanke indicated that further interest-rate cuts were now (then) off the table.

Although today's economic environment is radically different from a year ago, the dollar is once again clearly under major pressure once again while oil has just made seen its largest monthly gain in a decade (up 23 percent). Comments from both the king of Saudi Arabia and Oil Minister Ali Naimi in recent days indicated that the kingdom believes a range of $75 to $80 a barrel of oil is needed to encourage continued investment in the sector.

Indeed, the Oil Minister warned: "We are maintaining our long-term focus rather than being swayed by the volatility of short-term conditions. However, if others do not begin to invest similarly in new capacity expansion projects, we could see within two-to-three years another price spike similar to or worse than what we witnessed in 2008."

The other similarity to last year is that China has already expressed concerns about its exposure to the United States. Indeed, it can be expected that this will prove to be one of the central topics of conversation during Secretary Tim Geithner's visit to Beijing, also, next week.

So, it is certainly possible that next week's visit by President Obama could see some discussion of both the price of oil and the U.S. dollar. Given that the last thing the United States needs now is a rapidly rising oil price while the Saudis would, presumably, prefer a stable, to even rising, dollar, it is not inconceivable that an informal agreement of sorts could be in the cards.

Given this and given Secretary Geithner's visit to Beijing, I would not be surprised if increased official verbal support for a strong dollar to begin emerging over the next few weeks.

So, I don't see a substantial lower dollar in the near term.

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Speaking at the Seoul Digital Forum in Korea overnight, economist Nouriel Roubini gave, in my opinion, interesting comments that investors shouldn't overlook."We are not yet at the bottom of the United States and the global recession. … The contraction is still occurring...
Wednesday, 27 May 2009 10:15 AM
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