Don't Run From the U.S. Dollar's Reign

by Carl Delfeld

Don't Run From the U.S. Dollar's Reign

by Carl Delfeld, Investment U's Emerging Markets Expert

Thursday, May 5, 2011

The greenback gets no respect these days. In April alone, the U.S. dollar fell 3.8 percent against a basket of leading currencies. Today, it hit a dismal three-year low. This was in the midst of the S&P "warning" about America's AAA status.

Jim Rogers even recently suggested that the dollar could go to the value of confetti. Other investors are predicting that the U.S. currency is on its last legs.

Well, I hate to burst their bubble... The U.S. dollar is going to stay on top through the twenty-first century for two reasons: Its lack of competitors and its flexibility.

The Basic Characteristics of a Durable Reserve Currency

Both are important factors to observe after you look at the three basic characteristics of a durable reserve currency:

  • Durable reserve currencies are strong, stable and provide ample liquidity. A reserve currency should demonstrate deep liquidity so investors can move in and out of it without sharp movements in price. It also needs to be widely recognized by global investors as a reserve currency.
  • Reserve currencies require financial and political stability. The fiscal discipline and political stability of the country need to be unquestioned. Countries with large fiscal deficits are unable to be dependable safe havens since the path of least resistance is to devalue the currency to make debt loads more manageable.
  • Reserve currencies come from market-based, rules-driven, open economies. Investors and trading partners thrive best in a market-oriented economy where the rules are clear and transparent. Faith in the fairness of the judicial system and institutions is vitally important.

I know you're looking at the above characteristics on my reserve currency report card, and thinking, "The U.S. dollar is cooked." The United States scores well on liquidity (perhaps too well) and political stability, and is certainly one of the most market-based, rules-driven, open economies in the world.

Unfortunately, it scores a D- at best on store of value and fiscal discipline issues.

The Anti-Dollar Crowd Looks to the Euro and Redback

Because of this, the anti-dollar crowd is talking about the potential for a competitor currency. I understand their concerns.

But let me ask the obvious question: What competitors did they have in mind?

  • First, take look at the euro.

While the United States is on the mend from the global financial blowup, the Europeans have been in a nonstop financial crisis. Most of the continent's banks are not only shaky but also downright scary. German, U.K. and French banks are just trying to keep the balls in the air. That's not very reassuring. The monetary union needs to be a more closely aligned political and economic union. But that requires 26 states signing over their sovereignty. That's not going to happen anytime soon.

  • The other reserve idea on most pundits' lists is the Chinese yuan or renminbi - which is also being referred to as the "hongbi" or "redback."

On the issue of liquidity, the Chinese yuan is not even convertible. The country forces Chinese exporters who receive U.S. dollars to turn them over to the central bank. (This is how China built its $3 trillion in reserves.) Citizens can't take it out of the country. It's not accepted as legal tender anywhere outside of China.

The other problem with the yuan or renminbi is that it'll be a long, long time before China allows its currency to float freely. China built its entire system on tightly controlling their currency's value. If the currency strengthened 10 percent in six months, millions of exporters already on razor-thin margins would go bust. It would also be a volatile currency because of the economies dependent on so many commodities.

In addition, China's weaknesses as a global safe haven are glaringly obvious. Two examples should suffice: All of its strategic industries are firmly in state hands and its judicial system is anything but independent. That shouldn't instill much global confidence.

The U.S. Dollar Will Remain On Top

The U.S. dollar will remain on top because of the flexibility and the openness of our economic and political system. Sure, Congress won't solve our huge fiscal challenges overnight. But, I sense movement in the right direction. This and a credible medium-term plan to reduce debt spending could restore confidence in a hurry. So go ahead and hedge your global portfolio against a dollar decline with the Swiss franc (FXF) or the Australian dollar (FXA).

But don't go overboard and get bush wacked by a U.S. dollar snap back.

Good investing,

Carl Delfeld

Editor's Note: Carl Delfeld is certainty optimistic, but for good reason. You can read more about Carl's view of America's future by picking up Red, White & Bold: The New American Century. The book explains how the country can remain a dynamic global leader by following a simple pro-growth economic agenda, rebalancing eight key relationships, growing with emerging markets and pursuing a realistic China policy.

comments powered by Disqus