The US dollar has been depreciating vis-à-vis the euro as well as the Canadian dollar which is the currency of one of the largest trade partners of the United States. The Canadian dollar has moved from 67cents to the American dollar two years ago to well over parity in recent months. America’s trade with China records the highest deficit, and yet, the Chinese currency (the Yuan) appreciated vis-à-vis the dollar by 13 to 14 per cent in the past two years.
The reasons for a depreciating dollar are many. The budgetary deficit, uncertainty in Iraq, and the lurking problems for the last six months of sub-prime loans and derivatives programmes contributed largely to the depreciation.
Very recently, and despite the unprecedented moves to lower the discount rate by 0.75 per cent in one move, followed by another 0.50 percent reduction one week later, the dollar/euro parity has been improving somewhat. Obviously, the question is why? The answer is fairly straightforward. The reduction of the discount rate leads to lower interest rates on deposits and loans, and both developments contribute to further weakening of the dollar.
Dollar holdings by surplus countries are enormous. China has reserves equalling 1,300 billion USD, Abu Dhabi has reserves around 900 billion USD , Saudi Arabia and Kuwait hold around 500 billion USD together, as does Russia. Even Singapore, Brunei and Taiwan hold around 500 billion USD. The total amounts to 60 per cent of total world financial reserves. And, as the absolute majority of these reserves are in dollars, any decision to convert large proportions to other currencies would send the dollar into a downward spin, but this is unlikely to happen for the following reasons.
On the one hand, the US economy accounts for 25 per cent of the world economy, and in a globalised financial network of transfers seeking high returns, American assets are becoming relatively cheap. Moreover, the euro, which is the alternative financial instrument, is the currency of a large number of economies that have weakened in the past year. Growth in major euro European countries is now registering figures lower than two per cent. European exports are falling whereas American exports are increasing. The trade gap of the United States was narrowed by 100 billion USD in the last quarter of 2007.
Moreover, investments have been flowing from the Middle East and the Far East into American companies. City Bank alone attracted 25 billion USD, J.P. Morgan five billion USD, and Merrill Lynch five billion USD. One of the bonds insurance companies attracted one billion USD, and the property market attracted in the past two weeks investments exceeding three billion USD from Dubai and Holland. Major investments have also flooded in from Singapore, China, Abu Dhabi, Kuwait, Dubai, Saudi Arabia and Holland. The total investments in the past two months have probably exceeded 50 billion USD. City Bank, J.P. Morgan, Blackstone and Merrill Lynch have absorbed 45 billion USD.
It is likely that a further 50 billion USD of investments will flow into a US economy in recession in 2008. The alternative is represented by the euro, which will suffer from a lacklustre performance of major European economies due to much lower exports. Also, the other reserve alternative, gold, has become far too expensive. And, if oil prices remain high at 80 USD to 90 USD per barrel, the US will enjoy a better relative position than major European economies and Japan. This is because the US depends on imports to cover 50 per cent of its hydrocarbon (oil and gas) needs as opposed to 90 to 95 per cent in countries such as Germany, Italy, France, Spain, Portugal, Holland and Ireland.
It may be useful to remember that current banking woes first surfaced with Northern Rock in England when the bank accumulated losses of 20 billion USD. However, it may be surprising to know for some that the largest loss of all was recorded by Union des Banques Suisses, Switzerland’s largest bank which has so far declared 28 billion USD – exceeding the losses of City Bank amongst others. And, we should not forget Société Générale and its controversial 10 billion USD loss.
The markets have a way of correcting themselves of the greed that caused them to falter in the first place. Likewise the American dollar is an important currency that is in no way a washout in spite of the likelihood that the global economy will be affected by a recession. Crucially this is not some free-fall into an abyss. For the wily and seasoned investor, the punches the dollar is taking could, in fact, offer up some title-worthy gains.
