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THERE ARE TWO big issues facing investors when thinking about the US dollar — its valuation and its role as a global currency. The US dollar is at a turning point on both issues, facing what we believe will be a long secular decline on both fronts. This decline has only been temporarily suspended as a result of the crisis. Despite the economic failures in the US that were exposed by the crisis, investors fled to the safe haven of the only global currency available when confronted with the worst financial and economic crisis since the Great Depression — the US dollar. The real question is whether this recovery in the US dollar is sustainable.
But, first, what have been the main trends in the US dollar’s role and value over the past decade?
- The US dollar remains the preeminent currency for investors, including central banks, to store their savings in. Despite the occasional (but increasingly more frequent and more vocal) grumble, China, Japan, Russia and other major holders of large pools of savings still feel they have no choice but to continue placing a large portion of their savings in US dollars. But, the data from the International Monetary Fund shows a slow but perceptible shift away from the US dollar, with the euro’s share of global foreign exchange reserves inching up in recent years. There are also more currencies pegged to the euro than to the US dollar.
- The US dollar peaked in real, trade-weighted terms in February 2002, at 113.3, on the Federal Reserve Bank’s measure of the currency’s broad value. It then depreciated sharply to 85.2 by March 2008, a fall of almost 25%, which also brought it to its lowest value in decades, surpassing the previous trough of 84.8 in June 1995. Since March 2008, the US dollar has rebounded to 95.6, as panic-stricken investors switched to the safe haven of the US dollar in the crisis. In recent weeks, bouts of investor pessimism saw the US dollar rebound, while a return of risk appetites would see it depreciate.
Given these trends, what is the outlook for the US dollar?
