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US dollar to strengthen by 2009 due to positive long-term trends

21.11.2007
 
Pages: 12
US dollar to strengthen by 2009 due to positive long-term trends

At a summit of leaders from Organization of Petroleum Exporting Countries members in Riyadh, Saudi Arabia, Venezuelan head Hugo Chavez and Iranian President Mahmoud Ahmadinejad indicated the historic link between crude oil and the dollar should be severed.

Pravda.Ru has interviewed Dr. Nariman Behravesh, chief economist and executive vice president for Global Insight, and Dr. Christian E. Weller , senior fellow at the Center for American Progress and an Associate Professor of Public Policy at the University of Massachusetts Boston, to find out more about the tendencies connected with present-day US dollar setback.

Pravda.Ru: Can we speak here about a tendency of ditching the US dollar?

Nariman Behravesh: As a general comment, I don't take what Chavez and Ahmadinejad say very seriously, or in any way indicative of general trends in OPEC. Clearly OPEC and some Asian central banks are diversifying away from the dollar. This is a good thing. But it is only temporary. We believe that the dollar will strengthen again in late 2008 or early 2009 as the U.S. rebounds from its current downturn. The long-term trends (demographics, productivity etc.) are more positive for the U.S. than either Europe or Japan.

Christian Weller: The answer is yes and no. Yes, countries have been interested in general in diversifying out of the dollar. Japan, for instance, has been shifting its assets out of dollars since 2001 (by admission of the BOJ). The Japanese holdings of US treasuries show a turnaround in 2004. In August 2004, Japanese investors held $699.4 billion in treasuries. By September 2007, this number had fallen to $582.2 billion. These figures should not be influenced by exchange rate fluctuations, but because the dollar has weakened it should have become easier for Japanese investors (and more attractive) to invest in dollars. The fact that this hasn’t happened just reemphasizes the point that overseas investors were looking to put their money elsewhere. China has been looking to diversify into other currencies for a while. The main reason is simply financial economics. Putting too many eggs in one basket exposes countries to too much exchange rate risk, as many countries have recently learned the hard way.

The answer is also no, at least for now, since there really aren’t that many alternatives. The euro is the only world currency that has a market that is large enough to rival the dollar. The problem is that there is no unified euro market. There is the euro market in France, Germany, Italy, Greece, Denmark etc. The Europeans are interested in coordinating their financial markets, but for now, most of these markets are fairly small by themselves. Remember that the largest European financial market, London, is not part of the euro. The Japanese yen and the pound are still attractive investment currencies, especially since the British and Japanese economies are doing relatively well. But, the financial markets are no clear rival to the dollar. If they were, investors would have moved into these currencies years if not decades ago. So, for the time being, investors would like to diversify out of the dollar, but don’t have many opportunities to do so.

Also, keep in mind that the dollar still has a few things going for it: a) the US economy seems to be holding on alright despite the mortgage debacle, which signals to many investors and inherent stability of US financial markets, b) the US market is more liquid than any other market, c) the US trade deficit means that the US will have to borrow money overseas for the foreseeable future, which in turn means that policy makers, especially the Fed and the US government, have a strong incentive to keep the US an attractive place to invest, d) the dollar has a long history as a safe haven during troubled times, which was especially apparent after the Asian financial crisis. It will be a long time before other markets will replace the US dollars along all of these lines.

Pravda.Ru: Is it possible that other countries will try to break the connection between their national currencies and the US dollar?

Nariman Behravesh: It is possible that some countries (e.g. Saudi Arabia) will break the link to the dollar and move to a basket of currencies. This is also a good move, because an exchange rate that is fixed to the dollar can be inflationary for these economies.

Christian Weller: I am not quite sure if delinking oil and dollar is the same as delinking oil and local currencies. Only a few currencies are fully pegged to the dollar (Bolivia, Ecuador). Most other fixed exchange rate regimes, such as in the Baltic states, but also China, are links between the local currency and a basket of currencies, where the dollar is often an important minority share. The weaker dollar, though, should have helped these countries, many of which are export oriented in their development strategies to begin with. The opposite has been harder to swallow for countries. Just take the example of Argentina, which went into a major financial crisis because its currency was pegged to an overvalued currency. I would imagine that many countries that are tied to the dollar at this point are okay with it since it facilitates their exports.

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