The US dollar has become the Rodney Dangerfield of currencies: “it gets no respect!”
There are some compelling reasons for this lack of respect, the greatest of which is the flood of dollars that have magically appeared on the Fed’s balance sheet (which were then used to bail out large US banks). This flood of liquidity averted a global financial meltdown. But even Ray Charles can see that doubling the money supply will lead to inflation. This is not going to happen until banks start lending again. Right now banks are licking their wounds and recapitalizing. When they start to lend freely, inflation will kick in.
The Fed is planning to mop up that liquidity before the next big growth (and lending) cycle begins. Its success in reducing the money supply and raising interest rates, while not stunting the expansion of the global economy, will determine how much inflation we experience. The likelihood that they will time it exactly right is small, so we are likely to see inflation in the future. The best way to mitigate this risk is to own “stuff”: real estate, foreign stocks, domestic stocks with some exposure to foreign earnings, and commodities.
Two thirds of the world’s reserves are held in US dollars. Talk of other currencies usurping the dollar’s leadership role is interesting but I don’t see a serious contender to take its place. We might be at the beginning of the end of the dollar’s post World War II reign. If so, it’s the very beginning, and it will take a few years before a better option rises to the top of the currency heap. The demise of the dollar as the primary reserve currency is a long story and most of it has not been written yet. A lot of it will depend on how the Federal Reserve plays its cards over the next few years as we enter the next phase of the global business cycle. I believe the Federal Reserve has more mojo than the European Central Bank, or any other central bank for that matter. During the worst economic crisis in recent economic history, investors piled into US dollars, not the Euro (and not gold either).
I’m not a market technician, and I don’t play one on TV, but I suspect the dollar has been oversold. It’s a popular whipping boy and it’s trendy to rail against its inadequacy as a worthy store of wealth. But if we see some uncertain economic data, we’ll see it bounce back with a vengeance as investors flee gold and commodities to cash in their gains and protect their wealth in the lowly, United States greenback… or will it be the Euro?