Since the subprime crisis started in the United States in the middle of last year, the dollar has lost around 16% against the euro falling to lows not seen since the 1970s when the Nixon administration took the dollar off the gold standard.
The dollar’s decline is due to the aggressive monetary easing by the Federal Reserve which has led to an increasing interest rate differential between the United States and Europe. A weak dollar sustains US exports, which helps to contain the risk of recession in the United States.
The fall in the dollar also reflects a more fundamental concern, however. The Federal Reserve’s unorthodox measures break with its tradition of guaranteeing the dollar with uniquely US Treasury securities or gold. This break with tradition could undermine confidence in the currency and result in a situation similar to the 1970s, when the dollar was taken off the gold standard and subsequently lost nearly half of its value against the mark. Furthermore, the Federal Reserve is financed by the Treasury, which is in turn financed through bond issues. As the Federal Reserve has to inject more and more money to deal with the financial crisis, the fears of a fundamental decline in the value of the dollar via a ballooning deficit, coupled with increased inflation risks, could result in a confidence crisis.
In monetary terms, the world is moving away from a unipolar system based on the dollar to a bipolar system based on the dollar and the euro. The trend to diversify reserves away from the dollar to assets denominated in other currencies continues, led by the central banks in developing countries. The authorities of these countries traditionally tied their currency to the dollar and more or less imported the Federal Reserve's monetary policy. Today the US central bank's anti-recession monetary policy no longer suits the economic situation in these countries which are facing rapidly rising inflation. Consequently, many developing countries seem less and less likely to continue with the dollar peg and to accept the dollar as their de facto reserve currency.
Euro-based investors holding US dollars and who are reticent to sell the dollar against the euro at the current rate may be interested in the Singapore dollar (SGD). The value of the SGD is determined against a basket of currencies of Singapore’s main trading partners. The US dollar plays an important role in this basket and the SGD has therefore risen much more slowly against the greenback than the euro. The SGD has a promising long-term outlook given the fundamentals of the Singapore economy. The city-State has a very high current account surplus and enjoys strong economic growth (+7.2% 1st quarter year-on-year), driven by the manufacturing sector and its rise as a financial centre.
The Australian and New-Zealand dollars should also continue their secular rise against the greenback. After Canada, Australia could soon see its currency rise above parity with the US dollar.
