There is a big ongoing debate as to why the US dollar is losing its value against the global currencies? Why are countries switching to the Euro from the USD? Is this a Global Currency war? Is this a shift from the USD to other currencies, advantageous or otherwise to the global economies? Or is the weakness of the USD due to higher oil or gold prices?
Since March 2009, Russia and China have been very vocal and are showing concern about the weakness of the USD and have been challenging the US dollar's role as a benchmark currency. They took up the matter for the first time in the March G-20 meeting, demanding the replacement of USD by creation of some other reserve currency to secure global financial stability for economic growth. Recent reports suggest that Russia and China are joined by Middle Eastern Oil producing countries, although Iran has been demanding since long that oil should be traded in other major currencies.
After the Plaza Accord of 1985, USD is on a constant decline when global central banks called for "orderly appreciation of the main non-dollar currencies against dollar". It continued its co-ordinated intervention to ensure that it happens.
Euro was launched on January 01, 1999 and presently it is the second most traded currency and the second largest world reserve currency after USD. In 1995, the composition of world reserve currency after USD. In 1995, the composition of world reserve currency was USD 59%-D.Mark 16%-Yen 7%-Others 18%. In 2009, the break-up is roughly USD 63% - Euro 27% - GBP 4% - Yen 3.5%, etc.
The love for dollar is due to its stability, convertibility, ease of transfer, easy to hold. The greenback can easily change hands. It remains the most popular currency amongst the black-marketeers and those involved in illegal trades. Tourists from all over the world prefer cash USD.
Global loans are offered in US dollar based on Libor, which is a comfortable benchmark for lending purpose. Over 75 percent of the banks open letters of credit in USD, as the counter parties fix prices in dollar instead of local currencies or other major currencies to avoid exchange risk.
Though there are $500 and $1,000 bills already in existence, these are in small amount. Since the 1960s, Federal Reserve Bank routinely removes these notes from circulation and destroys them. It has become a collectors' item.
Sometime ago, information was provided to the US House of Representatives' Subcommittee on Domestic and International Monetary Policy and Committee on Banking and Financial Services that the bulk of $100 notes in circulation are outside USA, which could be roughly about two-thirds.
In January 2002, Larger Euro notes - 200 and 500 - were introduced. It is much easier to carry and hold, as the current value of Euro 500 note in USD terms is equivalent to USD 735. Another interesting feature of this development is that USD one million of $100 bill would roughly weigh 10 kilos (22 pounds), whereas Euro 500 note of USD one million equivalence would roughly weigh 1.36 kilo (3 pounds). Similarly, USD one million equivalent of a Pakistani rupee 5,000 note, which is almost the same in size of $100 bill but lighter in weight would roughly weigh 13-13.5 kilo (28-30 pounds).
But the shift in sentiment of switching from USD to Euro is not only due to decline in the value of USD, it is also because of the US economy's decline at a very fast pace. Since price of commodities such as oil, metals, food, etc is fixed and received in USD, the problem faced by these commodity-producing countries is that almost half of their imports are non-US dollar-based, which means when Euro, pound sterling or yen strengthen their imports become more expensive, whereas their export receivables are dollar-based. Hence, they have to pay more for their Non-Dollar purchases and simultaneously they are importing inflation.
A USD 14 trillion US Economy, which has always been considered as an engine for the growth of global economy, is in shambles. Unemployment is getting closer to 10%. US trade balance which was Zero in the 1970s went in to a deficit in 1982 by $20 billion and is currently USD 500 billion.
US domestic debt is close to $11 trillion and the budget deficit around USD 1.4 trillion or 13% of GDP. US Mortgage Debt amounts to USD 12 trillion, Unregulated Credit Default Swap, which rose to a high point of $62 trillion against the total global size of economy of roughly $60 trillion, is now reported to have thinned down to half the amount. Does common sense allow you to believe that all will soon be over? Furthermore, if oil and gold are on constant rise, this means inflation is in pipeline and is unavoidable, so does zero percent Fed rate and Quantitative Easing make much of a sense?
If we look at the currencies' past behaviour since January 1978, a one dollar note would fetch 250 yen; then oil was $13.40 per barrel. By January 1990 USD lost its value by 42% and a Dollar would then fetch 146 yen and oil was trading at $22.70 per barrel. In 2008-2009 yen hovered between 101-89 and oil traded between $147.80-$33.80 per barrel. From 1980 to 2009 pound vs dollar saw the highs of 2.23 and lows of 1.085. Sterling is currently trading at 1.5850.
In a broader perspective, Pakistan is less affected, as 75-78 percent of its trade is US dollar based. While, impact on the remaining part of the trade, which is in other major currencies, is minor, it could be roughly between 2% to 4%. The weakness of Rupee against dollar is having larger impact as in the calendar year 2009, Rupee has so far lost 5 percent of its value, it also adds to the inflationary pressure.
While, in a span of ten years' time, since the launching of Euro in January 1999, if we look at the composition of Global Currency Reserves position in 1999 USD would constitute 71 percent of the total Fx reserve portfolio. In 2009 Fx reserves portfolio in USD fell to around 63 percent, as during this period the US economy slipped at a slower pace.
Presently, market is nervous, unsure about the global recovery and in real terms the US Economic recovery is very unconvincing. US treasury requires more money due to looming budget deficit. BRIC countries are joined by other nations showing concern about the weakness of Dollar, suggesting that they are looking for new investment avenues and could slow investments in US Bonds. Hence, more notes will be printed, quantitative easing would continue and market will be flooded with cash Dollars.
Inflation will creep up faster then expected. Hence, the probability remains high that global Central Banks would shift Fx Reserves portfolio from USD at a speedy pace. But the bigger question is whether the BRIC economy will survive for next five years. China and India are more dependent on domestic growth, is this growth sustainable? What will happen if oil once again surpasses $100 per barrel? How would non-oil producing economies perform? In my view, dollar will make a comeback, unless oil stabilises at over $100 per barrel and countries start de-pegging against USD, though we may see some portfolio shift in Global investment strategy away from US dollar.
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