Opening Position
October 2010
The US dollar has long enjoyed its status as the world’s reserve currency, but given its declining value and the weak economic fundamentals in the United States, there has been a lot of speculation whether it will maintain that standing. The value of the dollar holds a strong position in the financial markets. As we know, oil and gold are priced in US dollars; in terms of international trade, the US is the world’s largest trader, and it is considered to be very stable. Any change in its value affects equity, bond, commodity, and the precious metals markets, which is why it’s a good idea for anyone trading the markets to keep an eye on the US Dollar Index.
Although the value of the dollar is not linked to its reserve currency status, we can’t ignore the fact that the dollar has been weak for the past eight years or so. If the dollar, for example, were to fall against the yen, Japan would see a significant decline in the value of its reserves that are held in US dollars. Naturally, they would want to hold assets in a different currency. But which one?
The euro was thought to be a viable candidate to be the world’s reserve currency at one time, but things haven’t looked too bright for it after the recent economic crisis in Europe. There is also a lot of debate as to whether a single currency system is the best thing for the European Union. The attention has now shifted to consider whether China’s yuan/renminbi would be a possible candidate to be the world’s reserve currency. Given that China holds a big chunk of US debt instruments, it shouldn’t come as a surprise that the Chinese would want another reserve currency. If China had regained its reputation as an international financial center, we could have seen the yuan as the next possible reserve currency.
While the confidence in the US dollar as the world’s reserve currency may have declined, there is no clear replacement currently in the horizon. It looks as though the US has bought itself some time. The dollar remains the most widely held currency, and the US is still a superpower. Can it remain that way? A reversal in the value of the dollar may help strengthen its foothold and help regain the support of the rest of the world, but keep in mind that a rally in the dollar could mean a decline in equities and commodities. That’s all the more reason to keep an eye on the US dollar.
Jayanthi Gopalakrishnan, Editor