The reign of the dollar is starting to wane.It will be a slow process, but in the next five to 10 years the dollar is expected to continue its gradual decline as central banks across the world diversify their foreign reserves into other leading currencies.
The dollar came under pressure after reports this week that talks have been held between China and Middle Eastern states about changing the pricing of oil from dollars to a basket of currencies and gold.
Thanos Papasavvas, head of currency management for Investec London, says his fund has been underweight in dollars since the beginning of the year as he believes that the longer-term trend will be for the dollar to weaken.
In the shorter term dollar, weakness has been driven by a return to emerging market assets. A combination of an increase in risk appetite and a perception of better growth prospects in the
developing world has seen portfolio flows returning to emerging markets. This has resulted in a weaker dollar and significantly stronger emerging currencies, the South African rand among them.
Michael Power, an Investec Asset Management strategist, believes that this is the start of a new era, which will see emerging markets such as China, India and Brazil challenging the dominance of the United States and the US currency.
Apart from a more positive story emanating from emerging markets, the US itself is looking increasingly vulnerable with burgeoning current account and budget deficits, which will ensure that the dollar remains under pressure over the medium to longer term.
Against this macroeconomic background, Papasavvas says central banks across the world are starting to diversify their foreign reserves away from US dollars into euros, yen, sterling and Australian dollars.
These will not replace the dollar as the world’s reserve currency in the near future because dollars will remain the major holding, but even if central banks reweighted portfolios from 60% dollars to about 50% it would mean a significant selling of dollars, considering that total foreign reserves clock in at more than US$6-trillion.
Papasavvas says periods of dollar strength will be used by central banks to sell the currency so any rally will be short lived. A weaker dollar is positive for gold because gold is considered an alternative currency to dollars.
Furthermore, as the global economy recovers and inflation fears are renewed, gold should benefit as a store of value.
However, many of these trends may already be factored into the gold price and the downside risk for the gold price is increasing, as the upward trend could reverse if we see a stronger dollar or a falter in global recovery.
Talks are under way for the creation of a super-currency which would include the Bric currencies: the Brazil real, the Russian ruble, the Indian rupee and the Chinese renminbi.
This new currency would be a representative price rather than a physical currency in the same way as the SDR (Special Drawings Right), which is the unit of measure of the International Monetary Fund. It will create a more stable currency measure for international trade.
The move indicates how important these currencies are in global trade. This is good news for the South African rand. If trade in Bric currencies increases and they become more liquid, so the rand could become less volatile.