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Are the days of the US dollar as a reserve currency numbered?

Many economic commentators questioned whether the Australian dollar would ever reach parity with the US. As we have exceeded all expectations, the strength of the US dollar as the global reserve currency has been brought into question. Subsequently, some countries such as China have called for a review of the position of the US dollar as a global reserve. However, there is pressure on financial markets globally – not just the US – and other currencies that could be considered alternatives to the US dollar are struggling as well.

What are the options?

“In the next five to ten years, there really is no alternative to the US dollar,” says Matthew Drennan, Executive General Manager – Zurich Investments. The Chinese RMB (Yuan) is the most likely single alternative, but this would require a floating currency and open capital account, which is not in China’s interests at present.
“The Chinese RMB (Yuan) has a closed capital account and is pegged to the US dollar in any case, so until Beijing changes the ground rules, the Yuan is not an option.” Drennan says.

The Yen is also in serious decline along with the Japanese economy, so he says the Yen is an unlikely contender as “no one wants to hold too much of that currency”.

The Swiss Franc is also another possibility, however, he says the depth of trade in the Franc is insufficient to cover global trading, hedging and/or speculative activity.

The Euro

This leaves the Euro as the real contender, says Drennan. “But at present there are serious questions over its survival, at least in its current form,” he says.

“Will Greece and Ireland be forced out eventually? Will the German public be prepared to stomach ongoing bailout packages, or will they revolt against the politicians who support these?”

While central banks around the world are diversifying their holdings away from the US dollar and US Treasury and towards the Euro and gold, Drennan says the Euro is light years away from replacing the US dollar as the world’s reserve currency for tradeable goods.

In light of the weakness of other world currencies, the US dollar seems set to hold its place – at least for the coming five to ten years – as the major global reserve currency.

Ultimately, however, with US growth severely constricted by debt problems, Drennan says it is likely in the longer term that another currency could take the place of the US dollar as the world’s reserve currency.

While the US dollar’s share of reserve has fallen over the last ten years, Ben Kilmartin, Director of currency advice and management firm BK Consulting, also believes that it’s unlikely that the US dollar will be superseded by another currency as a global reserve. “I don’t see that changing, certainly not in the next five to ten years,” he says.

Implications for Australia

While the Australian market is impacted by changes in the US economy and global market volatility, Kilmartin says the Australian dollar has held up remarkably well.

“The other thing that has held up the market well is growth outside the Western developed world, the emerging markets and Asian economies, which still seem to be ticking along nicely,” he says.

Forecasts for the global economy currently stand at about four per cent, and while there is market volatility, Kilmartin notes that global growth continues to march along at a reasonable pace.

“With that backdrop, I think the Australian economy should continue to do okay, on the back of strong Asian economic growth,” he says.

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