Relief for Ailing USD

Written by Research | 09 October 2009

Bernanke's Comments brings Relief for ailing US dollar

Federal Reserve Chairman Ben Bernanke sent the US Dollar higher in overnight trading as the markets latched on to comments saying the central bank was ready to “tighten” monetary policy once the economy improves, hinting that perhaps US policymakers have shortened their time frame for keeping rates in the ultra-low 0-0.25% target range.

Still, Bernanke cautioned that the Fed believes that “accommodative policies will likely be warranted for an extended period.” Profit-taking ahead of a three-day weekend in the US and Japan may have also led USD higher after the currency hit a fresh yearly low yesterday.

The Dollar Index, an average of the greenback’s value against six top currencies, gained as much as 0.5% ahead of the opening bell in Europe. We have seen some profit taking in Asia thus far, although the moves have been very mild. The Australian Dollar continues to outperform against all major currencies, with the exception of the buck on Friday. The relative strength in the commodity currency has been impressive and shows no signs of let up even after breaking psychological barriers by 0.9000.

The RBA rate hike and subsequent employment data this week have been the primary catalysts behind the antipodean moves. Even some reserved comments from Treasury Chief Henry on Friday have failed to weigh on the single currency. The buying back of the USD over the past few hours has been  attributed to comments from Fed Chief Bernanke who alluded to Fed tightening.

Meanwhile, US Treasury Summers has been on the wires reaffirming the US commitment to a strong USD policy. Meanwhile, the G7 concluded its latest round of talks. Despite previous indications to the contrary, the organization continued its practice of releasing a communique. in which it noted that global economic balances persist and that policymakers should work together to mitigate them. While seemingly benign and desirable, the proposition couldn’t have come at a worse time for the Dollar.

The only reason why the Dollar hasn’t collapsed completely is because economies largely continue to recycle their surplus wealth and trade surpluses back into Dollar-denominated assets. One columnist connects the dots with regard to the forex implications: “Less Chinese intervention to prevent yuan strength would mean China, slowly over time, would build up fewer dollar reserves.”

World Reserves:

In other words, economies no longer concerned with pegging their currencies would have very little reason to build up large pools of reserves. In fact, China is fully on board with this notion. Following the G7 talks, Chinese officials announced that it would support a stronger Yuan as soon as the global economic crisis resolved itself. By its own reckoning, this would facilitate a shift in its economy, from one dependent on exports for growth to one focused around domestic consumption. Still, obstacles remain and “It is far from clear how China can engineer a shift up for the yuan against the dollar, which analysts note would almost certainly translate into a gain against other currencies as well.”

Speaking of China, it is also among the most vocal of nations laboring for alternatives to the Dollar. Towards this end, it has reportedly formed a secret coalition with the other BRIC countries (Brazil, India, and Russia), as well as Japan. The goal is to end the pricing of oil in Dollars by 2018. That the group has given itself nine years to complete this task speaks to its extraordinary ambition.

The implications for the Dollar cannot be understated. A handful of oil-producing nations in the Middle East hold a combined $2.1 Trillion in Dollars, which are solely a product of selling oil in exchange for Dollars. Already, the government of Iran has mandated that in the future, all of its reserves be held in non-Dollar-denominated assets. Thus far, no other countries have followed suit. China is aware that pushing for further developments could roil the US, which would be unlikely to sit on the sidelines and watch its currency be summarily jettisoned. “Sun Bigan, China’s former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East.”

Robert Zoellick, president of the World Bank, doesn’t harbor any illusions, and announced during a recent speech that the a decline in the role of the Dollar is inevitable. “He said the United States ‘would be mistaken to take for granted the dollar’s place as the world’s predominant currency. Looking forward there will increasingly be other options to the dollar,’ ” such as the Chinese Yuan and the Euro.