US Dollar No Longer Dominant

Are the glory days of the US dollar fading? Is the US dollar no longer dominant in Forex markets? The Financial Times writes that the greenback is no longer the dominant safe haven currency.

Has the king of currencies been dethroned?

The dollar is no longer the catch-all haven currency of the past. Thank “idiosyncratic risks”, say analysts at Bank of America Merrill Lynch.

Adarsh Sinha, a strategist at the US investment bank, crunched the numbers and found the greenback hasn’t really been “safe” since 2014. It has tended to depreciate against most of the major currencies during nervous episodes, he notes.

“Perhaps unsurprisingly, this coincided with the end of Fed [quantitative easing] and the emergence of more aggressive easing by the European Central Bank and Bank of Japan,” said Mr Sinha.

Other analysts note that the dollar tends to be correlated with the S&P 500 which is a rough measure of the strength of the US economy. But during times of financial stress that relationship is not always a good thing. For those seeking a safe haven currency the likelihood of the dollar becoming volatile along with the US stock market is not reassuring. Japan’s yen comes in as the best safe haven currency as it holds up fine when Europe, North America and China are under financial stress. Unfortunately with trouble brewing next door on the Korean peninsula the yen has its problems as well.

Reserve Currencies

Investopedia in their article about Forex trading writes that the US dollar is the world’s most significant currency and the dominant reserve currency since World War II.

The United States dollar is by far the most significant currency in the global market; it is the dominant reserve currency of the world, it represents nearly half of the trading volume of the major currencies, and it is the default currency for most transactions. Given that the U.S. economy is far and away the largest single economy in the world (close to three times the size of second place China), it is not surprising that the U.S. dollar holds the position that it does.

Before the Second World War the British Pound occupied a position similar to what the dollar has today. That changed with the carnage of the war and Britain’s loss of its empire. Today nearly half of Forex trades include the dollar and the dollar is still the world’s leading reserve currency followed by the euro, yen pound and Swiss franc. But the change over the years is telling. Between 1999 and 2013 the percent of total foreign currency reserves held as dollars fell from 71% to 61% while euro climbed from 17.9% to 24.4%. The percentages for the pound, euro and franc rose slightly while yen also experienced a drop from 6.4% to 3.8%.

The Passage of Time

All things change over time. The fundamental value of a currency depends on the strength of its economy, its balance of payments and its monetary policy. In the case of the US dollar it also depends on the US congress dealing responsibly with the huge US debt. Over the years the debt has grown and so has political divisiveness. That is a recipe for disaster and not good for the dollar. When foreign governments decide which currency to put away in reserve they want the one that has a responsible monetary policy and responsible government attached. It remains to be seen how this will work out for the US dollar and its current dominance.