The dollar’s status as the world’s pre-eminent reserve currency is under threat as the country faces a growing budgetary crisis, says Jerome Booth, head of research at emerging markets asset manager, Ashmore Investments.
Speaking at Euromoney’s Forex Forum last week, Booth told delegates that loose fiscal and monetary policy in the US was hastening an era of global rebalancing, with investors keen to buy other assets at the expense of US Treasury bonds.
“There’s a huge appetite to diversify away from the dollar,” Booth argued. “It’s not possible to carry on like this. We’ll see a huge shift in the reserve basis to other currencies that more accurately reflect the makeup of the global economy.”
Investors are increasingly looking to hold euro and yuan reserves, Booth said. He added that the yuan’s non-convertible status did not exclude it from being a global reserve currency.
He compared the situation to that of the deutschmark’s status as the second global reserve currency in pre-euro days, when German banks allowed foreign investors to purchase deutschmarks during buying windows.
Some 50% of US Treasuries are held by foreign central banks, Booth told the delegates. He suggested that, if the Federal Reserve decided to re-purchase bonds from central banks looking to sell, other external buyers in the market would be likely withdraw, leading to a crash in the dollar’s value.
He added that China had purchased no Treasuries since the Federal Reserve began its second round of quantitative easing in November.
Booth believes the real motive behind quantitative easing was to aid the US banking sector, by driving up asset prices and allowing banks to recapitalise themselves. The policy’s impact on the real economy was yet to be felt, he said.
Fiscal issues were also to blame for dollar weakness, Booth argued, by suggesting that just as many US states were effectively bankrupt, as the number of euro member states that have had already been bailed out by the EU and IMF.
He likened budget deficit weakness in Europe and the US to having a dead body on the floor, arguing that structural debt issues could not be ignored indefinitely. “Europe have put a sheet over the body and said, ‘We’ll deal with it later’. In the US, they’ve put the dead body in a chair, given it a cup of coffee, and they're talking to it.”
Booth argued that the cycle of the dollar as a flight to safety currency during market crises was being broken down, saying that the recent Japanese earthquake was a case in point, where even though Treasury yields rallied, the dollar actually fell against the Yen.
He returned to the history books to back up his thesis that the dollar has become one of the world’s riskier currencies. Comparing the current situation to the post-war Bretton Woods agreement – where global currencies were pegged to dollar – which in tandem with the Marshall Plan, helped fund the reconstruction of Europe. It eventually led to a shift in the terms of trade against US, however, allowing huge trade imbalances to build up.
The system eventually broke down as US debt outstripped available gold reserves. Other countries triggered the breakdown by revaluing their currencies – such as France and Italy, and then the UK. “Compare the situation with that of Asia today,” Booth concluded. “That rebalancing has not yet happened.”