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Sun 1 Mar 2009 04:00 AM

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Dollar is best looker in ugly currency parade

Relative to other currencies, the dollar is looking better by the day, argues Michael R Sesit.

Last month, Russian Prime Minister Vladimir Putin labelled the world's reliance on the dollar "dangerous" and called for an "irreversible switch-over" to a system of multiple reserve currencies. Dream on, Mr Putin.

To end the dollar's reserve currency role, you need a replacement. There is none. The euro is a multinational creation, belonging to no specific country and adopted by 16 nations, several of which are economic basket cases. The yen and the pound aren't used enough in international trade and financial transactions. China's yuan isn't freely traded or exchangeable.

What's more, bulging budget deficits, massive borrowing programmes, runaway spending, a crippled economy, a dysfunctional banking system and rock-bottom central bank interest rates would ordinarily sound the death knell for a currency. Not the dollar. Not this time. And certainly not because the greenback is a particularly good-looking investment.

On the contrary, it is the least unattractive of the collection of ugly sisters that populate the world's major currency markets.

Industrial production in Europe and Japan is plunging. World trade is set to contract for the first time in 27 years, sucking the mighty German export machine down a plughole.

Bank of England deputy governor John Gieve last week said there is a risk that the UK may face a decade-long slump similar to the one Japan experienced in the 1990s.

Japan's economy, the world's second-largest, tumbled 3.3 percent in the fourth quarter from the previous one, while Germany contracted a seasonally adjusted 2.1 percent; and the euro area shrank 1.5 percent. By comparison, the US's one percent fourth-quarter decline looks almost stellar.

Meanwhile, the International Monetary Fund forecasts the UK economy to contract 2.8 percent this year. That's the most since 1946 and the worst performance among the Group of Seven nations.

The interest rate picture is no prettier. This past July, the European Central Bank's borrowing costs were 225 basis points more than the Federal Reserve's federal funds rate, and the Bank of England's benchmark was 300 basis points higher. Rising interest rates can often increase a currency's allure to investors.

Now, official UK rates are just 75 points more than their US equivalent. The ECB's are 175 points higher. ECB board members are signalling a further cut on March 5. The narrowing interest rate differential has helped the dollar's 23 percent rally to $1.28 against the euro and 37 percent advance to $1.45 against sterling since early July.

The ECB is in a bind. Inflexible labour markets and a lack of competition make inflation more persistent than in the US, yet the longer the central bank baulks at cutting rates, the deeper the continent's recession and the weaker the euro.

At the same time, the ECB has less flexibility in purchasing government securities than the Fed, which is contemplating buying longer-maturity Treasury bonds.

European Union rules prohibit the ECB from purchasing bonds directly from governments, and a decision to buy debt in the open market may trigger a dispute over which country's securities to purchase.

More aggressive and faster in confronting the banking crisis and ensuing economic decline, the US will emerge from recession sooner than most other economies. That's another dollar positive.

For all their warts, US banks, unlike their European counterparts, don't suffer from the East European disease that weighs on the euro. As of last September, European lenders accounted for 91 percent of the $1.66 trillion in loans made to East European banks, according to the Bank for International Settlements.

Russia, Hungary, Romania, Bulgaria, Estonia, Latvia, Lithuania and Ukraine have had their credit ratings cut in the past six months.

Americans are now saving more while spending and importing less. As they do, the current account deficit will narrow and the US will become less dependent on foreigners to finance the gap. The deficit amounted to 4.8 percent of gross domestic product in the third quarter, having been as large as 6.6 percent of GDP in the last quarter of 2005.

"Every prior economic and political crisis the US has faced that required massive government spending and bloated government deficits - including the Great Depression and World War II - has been followed by periods of technological innovation, productivity enhancements and a much larger economy," says David Gilmore, a partner at Foreign Exchange Analytics in Essex, Connecticut.

Those innovations and productivity gains contributed to a big decline in the ratio of America's debt to GDP.

The dollar may be ugly, but relative to other currencies, it's looking better by the day.

Michael R Sesit is a Bloomberg News columnist. The opinions expressed are his own.

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vansen 11 years ago

Ignoring fundamentals is not the way to write an article read by many. The US dollar, like all fiat currency, is backed by no tangible asset. When that currency's supply increases by well over 400% in less than 12 months (unprecedented) you will, by way of economic law, have a devaluation of that currency relative to assets of true worth and intrinsic value; therefore massive inflation is on the way if you hold US dollars. Now, because most economies that are aligned with the US are overprinting their currencies in near sync with the US Federal reserve, the value of the dollar seems stable. The value of currencies relative to other currencies is irrelevant so as long as those currencies do not increase their savings in real goods, therefore bettering their fractional reserve. Simplistically, the comparison of fiat currency versus itself is false, but the value of currency vs. true assets (commodities) is what is relevant. Therefore, the overproduction of any fiat currency will, by the laws of economics, create the perception of inflation via the deflation of those currencies. And by the way, the US economy contracted NOT by 1% in the fourth quarter of 2008, as the article above states, but by 6.2% in the same quarter; and that is according to the: US Department of Commerce.

Hamid 11 years ago

I think Michael R Sesit made a very nice analyzes of currencies and I agree. However, I think he is little bit downplaying the ever growing U.S. debt and deficit. Not to mention U.S. loss of competitiveness in most industries, especially car making and electronics. But, on the whole, I must agree dollar seems to be the least ugly sister.