The dollar has enjoyed a meteoric rise since the middle of 2014, reaching highs against major currencies not seen since before the global downturn.
Analysts generally believe the momentum will continue gathering pace during 2015 despite a growing school of thought forecasting quite the opposite for the world's trading currency.
First, let's take a closer look at the background of the dollar and its rise in importance over the last 70 years. It's a tale containing Machiavellian twists and the creation of artificial dollar demand around the world:
- The Bretton Woods agreement of 1944 marked the creation of fixed exchange rates between countries based on the value of their respective currency to the dollar and indirectly the price of gold which is traded in dollars even today. This was the 'dollars for gold' era.
- Since the introduction of floating exchange rates in 1971 after the Smithsonian Agreement, the dollar has remained de facto world currency. Mainly engineered by Richard Nixon and his global sidekick Henry Kissinger a powerful deal was cut with Saudi Arabia's royal family that saw the introduction of the Petrodollar.
- According to the agreement, the US would offer military protection for Saudi Arabia's oil fields, provide them with weapons and importantly, guarantee protection from Israel.
- In a shift from 'dollars for gold' to 'dollars for oil', the currency successfully maintained its position as the global trading currency through the creation of a consistent but largely artificial demand.
- Oil producing nations collect dollars in exchange for oil and recycle those petrodollars back into US T-bonds and equities, thereby supporting the dollar and the US stock and bond markets.
- For the following decades, the dollar has also been the world's principal reserve currency, accounting for more than two-thirds of total foreign exchange reserves, compared to around a quarter held in euros.
Threats to the Dollar's Global Dominance
It is widely believed that current dollar strength is more to do with relative weakness in other economies, with growing concerns that a potential devaluation of the currency is imminent. It's far from plain sailing for the green back, particularly when influenced by some pretty powerful forces:
- As the world's second largest exporter, dollar strength can be catastrophic to America and economists have reduced expectations for US economic growth in 2015. This is largely due to markets being pushed into negative territory by dramatically falling sales as US products become more expensive in the global marketplace.
- The creation of the Asian Infrastructure Investment Bank (AIIB) is clearly a threat to dollar dominance. With more than 50 nations joined as founding members including the UK, France, Germany, Australia, UAE, Saudi and Qatar together with most of Asia, the AIIB will boost China's influence internationally and significantly enhance its soft power, while eroding America's international influence through the World Bank and ADB.
- China's unknown gold reserves pose a significant threat to the dollar's value, mainly because the nation has not quantified its gold holdings since 2009. It is unlikely China will release the figure until it is politically expedient to do so and until such times, will remain a lurking threat to US strength. Depending on the amount of gold held in reserve, the announcement could be a major catalyst for the gold market, sending prices through the roof and traditional correlation shows that when gold goes up, the dollar goes down.
- An historic energy deal made between Chinese President Xi Jinping and Russian President Vladimir Putin last year will see around $400bn of natural gas exported to China over the next 30 years, representing around 25% of the nation's energy needs. This contract opens Russian access to other Asian countries as well, making this deal a very momentous one. The most significant twist this brings to America's fortunes is that transactions are to be in yuan and roubles rather than dollars – a significant blow to the petrodollar.
The dollar's demise has been subject to speculation for many years, mainly due to highly convincing arguments for its collapse like a soaring debt mountain, deficit, unbridled money printing, demographics, rise of China, death of the petro-dollar and sundry other potential catalysts. However, the fact is the dollar is still the global trading and reserve currency and is likely to remain so – by whatever measures the US government deems fit to keep the status quo.
- Tuesday 02 June 2015