End of the road for the dollar?

March 25, 2009 — Mitul Kotecha

The comments by China’s central bank governor  about the US dollar have provoked much speculation ahead of next week’s G20 meeting in London about the potential for the world’s biggest reserves holder (around $2 trillion) to shift away from dollars. The idea of China’s central bank governor is to use SDRs as an alternative to the US dollar. China’s concerns focus on the risks of a big increase in inflation in the wake of the Fed’s plan to move to full blown quantitative easing by buying US Treasuries as well as the massive blowout in the US budget deficit. This would hit the value of China’s massive (over $700 billion) holdings of US Treasuries.

Don’t get too excited though. The likelihood of any change in the use of the dollar as a reserve currency is extremely limited. Using the SDR would itself involve many technical issues in terms of how much to issue and whether companies and investors would accept the use of SDRs rather than dollars. Such a move would take years. The reality is that the risks to the dollar have clearly risen and the crisis and money printing by the Fed has fuelled significant risks over the medium term, to foreign holders of US debt such as China. Nonetheless, there is no other currency that is in a position to displace it at the moment and possibly for several years. Eventually the use of the euro and even the Chinese yuan may reach a point when they share the status of reserve currency with the dollar, but this is not going to happen anytime soon. In other words there is no need to go get rid of your Greenbacks just yet.

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Running out of steam

March 25, 2009 — Mitul Kotecha

The euphoria in markets over recent days appears to be fading but only after a fairly solid rally in equities amounting to around 20% in some stock indices from their lows. Financials have led the gains over recent weeks helped more recently by a warm reception to US Treasury Secretary Geithner’s plans to fix banks.

Although I am doubtful about the staying power of the recent improvement in market sentiment I have to admit that there are clearly positive steps in action in the US both from the Fed and the US Treasury.  In fact the US authorites have gone all out to get things turned round.  This appears to have put a floor under risk appetite for now. 

Ok there are still a lot of questions to be asked such as how quickly the Geithner’s bank plan will work or whether banks will be unwilling to offload toxic debt at a significant loss or whether the deal is a raw one for US tax payers who seem to be bearing most of the downside and not too much upside if things go well.  All of that aside something is better than nothing even with its faults.

As for equity markets this still smells like a bear market rally or put another way a dead cat bounce.   I could be wrong and will be happily eat my words but I can’t see how the rally can be justified given the struggle ahead for both banks and the economy.   At best, what to expect is a period of high volatility before a real recovery arrives. 

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