Looming dangers for the dollar
Published: March 31 2008 19:21 | Last updated: March 31 2008 19:21
Sick as a sovereign wealth fund: how better to describe an investor who has done a very large and exceptionally badly performing deal? In the space of just a few months, SWFs from Asia and the Middle East have lost billions of dollars by recapitalising western banks. Such losses, and the rapid fall in the US currency, increase the risk that foreign investors will lose their appetite for dollar assets.
Abu Dhabi’s implied capital loss on its investment in Citigroup is about $2.5bn since last November. December’s investment in Merrill Lynch by Temasek of Singapore is off about $600m. Even that looks a lot healthier than its compatriot fund GIC, which alongside a still unnamed Saudi investor is down by about $5.5bn on its investment in UBS of Switzerland.
Those losses are dwarfed, however, by those that central banks are making on their dollar reserve assets after repeated cuts in US interest rates. Even those SWFs that have not swooped recently on distressed bank assets are hurting because of the sheer volume of their accumulated dollar assets. There are signs that some foreign investors are losing patience: South Korea’s $220bn National Pension Service has suggested it may sell US Treasuries and buy higher-yielding European government debt.
Rejection of dollar assets is dangerous for the US. A short-run risk is that US companies lose an advantage in international commerce: the willingness of their trading partners to price in dollars and so bear all of the currency risk.
A medium-run risk – the most important – is of a disorderly flight from dollar assets that makes Federal Reserve monetary policy ineffective, blunting its sword.
But a long-run risk is that the dollar loses its status as reserve currency. At present, foreigners’ desire to hold dollar cash and bonds as a store of value allows the US to finance its debt at low cost. The loss of that status would mean a permanent loss of wealth for the US.
It is, nonetheless, unlikely to happen: euros, the only viable alternative, may be issued by a giant economic bloc but the EU lacks the geopolitical power and deep, unified asset markets that make dollars the reserve currency of choice.
Inertia means that the euro would have to be far superior to the dollar to induce reserve investors to switch. But the sine qua non of a reserve currency – held to protect against the unpleasant shocks that may hit one’s own money – is stability. If the Federal Reserve’s aggressive rate cuts unleash sustained inflation, the pre-eminence of the dollar will be tested.
Copyright The Financial Times Limited 2008 |
