May 122011
 

So you think the dollar is washed up as a reserve currency, destined to live up to the jibe “American peso.” Better whip out your library card and retrieve the column of Mansoor Mohi-uddin, managing director of foreign-exchange strategy at  UBS, on Page 22 of the Financial Times May 11, 2011.

Dollar bears have been in the driver’s seat so far this year, pushing the currency to 16-month low against the euro and pound and all-time lows against the Swiss franc and Japanese yen. The reasons are familiar to anyone who’s been paying attention. They include the relatively weak U.S. recovery, huge budget deficits, political gridlock and the Fed’s money-printing program.

Recent rumblings in the euro zone, specifically about the need to bail out Greece, have arrested the dollar’s slide. Mohi-uddin ticks off a number of reasons why the dollar is likely to do better in the second half and beyond. Among them:

>The U.S. Treasury market is unmatched in depth and liquidity, which makes it the destination of choice for risk-averse investors.

>The euro’s woes show there is still no challenger to the dollar as the globe’s reserve currency. The yen? Japan, now the world’s third-largest economy (after China), is hamstrung by high debt (twice as high in relation to the size of the economy as in the U.S.). The Swiss franc? The bond market there is just too small to accommodate central-bank reserve flows. China’s renminbi? Capital controls limit liquidity.

>Then there are the political connections. Several countries with large foreign-exchange reserves are sheltered by the U.S. military umbrella — among them Japan, South Korea, Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates. “It is in their interests,” writes Mohi-uddin, “to ensure the greenback does not face undue pressure in the currency markets.”

>The U.S. has flexibility to deal with its financial problems. An independent Fed can set monetary policy while the dollar adjusts to the needs of the domestic economy. Individual memebers of the euro zone, by contrast, “are unable to set interest rates or pursue separate exchange rate policies to support their economies.”

Yes, the dollar has been beat up lately, but don’t be too quick to sell the dollar short. Mohi-uddin concludes: “In short, the greenback’s outlook appears constructive for the rest of 2011. Its status will only serve to enhance its appeal during any further bouts of risk aversion.” And more turmoil in the euro zone is almost certain. Prominent on Page 1 of that issue of the Financial Times is a tease: “Why Greece will default.” It is a reference to a column inside by Martin Wolf, the newspaper’s excellent chief economics columnist. Such words are likely to be music to the ears of dollar bulls like Mohi-uddin.

 

 

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