The U.S. dollar was supposed to be at the end of its rope. Kicking the bucket. A dying symbol of a dying empire. Well, maybe not. The dollar continues to defy gloom-and-doom predictions. After a swoon last year, the dollar is again enjoying a major rally. The U.S. dollar index, which measures the greenback’s value against other major currencies, is just off an eight-month high. Like the slasher in a cheesy horror flick, the dollar keeps coming back for another go, just when you least expect it.
The main reason behind the dollar’s recovery is actually no real surprise at all. There is no alternative able to replace the dollar as the world’s No.1 currency. What makes currencies so fascinating is that their perceived value is always relative to other currencies. Sure, the U.S. budget deficit is expanding, the government’s debt is increasing, and Wall Street is still repairing itself. But the dollar remains the prettiest of a flock of ugly ducklings. Is any other major industrialized economy particularly better off than the U.S.? Not really. Just about the entire developed world is suffering with the same problems. That’s why when investors get nervous (and there are plenty of reasons these days to be nervous), they still rush to the good old greenback. The dollar wins because no one else is really in the game.
The euro has been exposed as a fraud. Only a few months ago, economists truly believed the euro could rival the dollar as the top reserve currency. Now experts are questioning if the euro has a future at all. The Greek debt crisis has revealed that the euro is only as strong as its weakest link. And when your weakest links are nicknamed PIIGS, you know you’re in trouble. Watching the eurozone’s ministers fumble about over a solution doesn’t inspire much confidence, either. Clearly, there is a need for some mechanism within the eurozone to support ailing members to ensure the euro’s stability, but the better-off nations don’t appear willing to absorb the political risk of taking on that responsibility. And those “better-off” economies aren’t in great shape either. The Organization for Economic Cooperation and Development estimates France’s government debt-to-GDP ratio at 85% — a touch higher than America’s – while Germany’s is at 77%.
And after the euro, where do global investors turn? The yen? (I’m laughing as I’m typing.) Japan’s economy, with higher government debt and crushing deflation, has even deeper structural problems than America’s.
The dollar, of course, could slump once again if the Europeans miraculously get their act together, or if Washington fails to show the necessary commitment to fixing its own financial house. But the lack of viable alternatives to the dollar could remain a reality for some time. The suggestion raised by the Chinese last year of elevating a supranational currency, such as the International Monetary Fund’s Special Drawing Rights, to new status as a major international currency has gone absolutely nowhere.
Maybe over the next 20 or 30 years, the dollar will slowly lose the dominant status it holds today. That process, however, could well be driven by the appearance of new contenders. What is likely coming in global currency markets is a reassessment of what is a risky currency and what is not. Right now, emerging market currencies, such as China’s yuan or India’s rupee, are not considered trustworthy enough by central bankers and investors. The perception of risk is still too high (or the degree of controls too great – for example, the yuan isn’t fully convertible). But over time, that perception could change as these economies modernize and advance. Then the dollar really could be doomed.