FYI | Feb 28 2008
By Greg Peel
There’s no denying it. There are many in the world, friend or foe, who are deriving a perverse satisfaction from watching the great global reserve currency sink into the dust. Before the credit crunch hit, the US dollar was already drifting lower under the weight of the burgeoning US current account deficit, which had ballooned on American consumer profligacy. The slope of the slide became steeper when housing collapsed and credit markets imploded, and the Fed started slashing rates to save the world’s largest economy.
Across the globe, enemies and allies alike began to turn their backs on the dollar, preferring to diversify foreign reserves into other stable reserve currencies, such as the euro. Saks Fifth Avenue is now filled with the babble of foreign accents as Europeans exploit their soaring exchange rate to fly to New York for a shopping spree, as if they were catching a bus downtown. China has threatened to withdraw its significant US Treasury holdings if the US government bows to protectionist pressures. Middle Eastern enemies have delighted in attempting to move oil trade into other currencies. Middle Eastern allies have apologetically looked towards unpegging their currencies from the greenback. And now Russia wants to make the ruble the reserve currency of Eastern Europe.
Yes – the ruble. The currency which, at the fall of communism and under the stewardship of Boris Yeltsin, fell to a value below the paper each note was printed on. It was the collapse of the ruble (via Russia’s default on sovereign bonds) that caused the last great financial scare in 1998 when LTCM went under. But since the US dollar has weakened, and the oil price has risen as a result and as a result of global demand, the ruble has appreciated 30%. Russia is parochially proud of its ruble and, despite a supposed defrosting of the Cold War, would love to stick it right up the Americans.
Russia is the second largest oil exporting nation after Saudi Arabia, and the plans are to softly softly move oil receipts out of the global benchmark greenback and into the glorious local currency. Sceptics find it difficult to conceive of the world accepting commodity trade in the ruble, but Russia is serious. As we speak, a new glass skyscraper is rising in St Petersburg which will become the Russian commodities exchange. Grain, sugar, fertiliser, cement, beef and pork contracts will trade on the exchange – in rubles. (What? No vodka?)
Iran has also been talking about an exchange for oil and other commodities since 2005, but one is yet to eventuate. Iran would find it difficult to attract foreign traders to help get an exchange happening if there are no bars nearby. Nevertheless, one bone of contention is as to what currency would be adopted. For obvious reasons, the greenback is not high on the popularity list. Iran is now also considering the ruble.
All of this abandonment of the US dollar might be great sport, but the reality is a crashing reserve currency is causing all sorts of problems around the globe. Apart from losing on dollar-denominated exports, the rest of the world is suffering dollar-led inflation as commodity prices soar. One response is to switch to local currencies, but the subsequent strength in local currencies is now rendering businesses uncompetitive.
The ECB has to date staunchly refused to cut the European Union interest rate from 4% due to rising inflation. As the Fed has slashed its rate from 5.25% to 3% and will soon slash again, the euro has moved to an all-time high over US$1.50. European businesses are now threatening action if the ECB does not ease. BMW is cutting 5,600 jobs in Germany and will cut more if no action is taken. It would be cheaper for BMW to move production to a dollar-denominated country such as (oh the irony) the US.
Airbus, already suffering delays on the delivery of its new generation of aircraft, has said US$1.50 is the limit before it has to take drastic action to meet delivery contracts denominated in US dollars. The peasants are storming the Bastille.
The problems within the European Union are exacerbated by its tenuous structure. Sovereign bonds of the countries in more serious economic trouble, such as Spain, Italy and Greece, are being heavily sold in favour of more stable German and French paper, threatening to destabilise the whole euro-based system. Outspoken French President Sarkozy has demanded the ECB activates the so-called “nuclear option”, where Trichet and co open manilla envelopes and enter codes into the computer that will allow EU politicians to dictate exchange policy.
But European inflation is running at 3.2%, the highest level since the launch of the common currency. As Trichet refuses to budge, speculators are pouring money into the euro and pushing its value ever higher. However, observers suggest the euro may soon find itself correcting rapidly when the European economy implodes under the weight of its overpriced goods.
Asia is suffering similar problems. The Philippine peso is now at an 8-year high to the US dollar, the Malaysian ringgit is at an almost 3-year high and the Taiwan dollar is at a decade high. The central banks of these three countries were forced to step into forex markets this week to try to keep a lid on currency movements. Once again, it is fears of falling export receipts and the subsequent economic impact that has Asia worried. While China’s currency is pegged, the managed peg has also allowed the renminbi to rise, threatening already minimal export margins.
On the flipside however, Asia is suffering runaway inflation. Singapore’s CPI was 6.6% in January, the highest level in 25 years. Asia has been content to let its currencies rise as a curb against inflation, as lower export receipts mean lower income. But Singapore and Thailand have both been ready to step in and buy dollars, as well as the aforementioned countries, as their currencies soar.
Just like Ben Bernanke, Asia will be feeling a bit “damned if you do, damned if you don’t”.
Stagflation is a threat across the globe. The Fed’s aggressive rate cutting policy is not helping.
