One of the biggest economic paradoxes of this year was that of the United States dollar. As the American economy buckled, its financial and manufacturing sectors shaken by failures and bailouts, its currency continued to appreciate.
One explanation is that the greenback is not just the currency of the US anymore, but that of the world. Since the collapse of the gold standard, many central banks have denominated their foreign reserves largely in dollars, banking on the US economy’s relative stability.
And many countries, including those in the Gulf, still peg their currencies directly to the dollar. Egypt dropped its peg to the dollar in 2003, but the relationship between the two currencies has remained intimate.
An upshot of all this is that even when the US economy slumps, demand for its currency stays high. This aside, most experts say the dollar will likely see its status as the world’s go-to reserve decline.
“The US dollar remains the world s reserve currency, and I think it will appreciate in the next months because the US economy will be the first to come out of the recession, said Mauro Guillen, director of the Lauder Institute at the Wharton School. “Having said that, the golden days of the all-dominant dollar are over.
As a new order emerges, many developing nations – particularly those whose currencies are pegged to the dollar – will likely need to retool their policies. A basket of currencies including the dollar, the euro, the British pound, the yen and the Swiss franc is the best strategy, Guillen suggests.
New currency mixes will result largely from three factors, says Monal Abdel-Baki, a professor at the American University in Cairo.
First, a nation will need to consider its trading partners. Many countries, especially nations in the Gulf, are already diversifying their foreign reserves according to trade conducted with trade partners, Abdel-Baki said.
Second, to whom a nation owes money will play a role, particularly as many lending terms already require indebted nations to hold reserves corresponding to their foreign debt.
Third, nations will need to evaluate whether a currency is likely to depreciate or appreciate.
Less than 20 percent of Egypt’s imports come from the US, while about 37 percent come from the European Union. Yet nearly 42 percent of Egypt’s debt is in US dollars, with just 32 percent in euros, Abdel-Baki said. This means the bulk of Egypt’s $35 billion in reserves will likely stay in dollars for some time.
Still, the country will have to diversify to some degree, Abdel-Baki suggests. Because of its fiscal situation, the central bank should give more weight to the denomination of its foreign debt, and try to hedge against fluctuations in foreign exchange rates by employing investment bankers and portfolio managers, she says. For now, trade is of less importance.
One consequence of the accumulation of large foreign reserves in China, India, Singapore and other countries is that the dollar’s longer-term stability could fall largely into the hands of Asian governments.
Countries with large reserves could threaten the stability of the dollar and other currencies by heavily selling or buying that currency.
For the time being, however, the dollar will likely hold off any broader instability, as countries bank on it at least for the short term. Over recent months, the greenback has risen against the euro, yen and British pound.