Dollar Demise Widely Exaggerated

The reserve currency topic comes and goes, and anytime a development takes place that appears to run counter to the dollar’s status as a reserve currency, the horns blare with warnings about the end being near. I can see how the dollar will run into problems because of the debt, and high rates across the globe are in the cards, even without economic growth. But ultimately it’s about consumption, risk and trust.

Bloomberg’s article “China, Japan to Back Direct Trade of Currencies” provided additional ammunition to the argument that the dollar is doomed.

Japan and China will promote direct trading of the yen and yuan without using dollars and will encourage the development of a market for companies involved in the exchanges, the Japanese government said.

In other news, “Japan, India Seal $15 Billion Currency Swap Arrangement to Shore Up Rupee,” as reported by Bloomberg, and showing how dollar-centric the global economy still is.

Japan agreed to make $15 billion available to India in a currency swap arrangement as Europe’s deepening debt crisis threatens to curtail developing Asia’s access to dollar funding.

In addition,

Reserves in Japan swelled to $1.22 trillion in November from $1.04 trillion at the end of last year, propelled in part by a resumption of currency intervention under Noda, starting with one round in September 2010 when he was finance minister. With Noda as prime minister, yen sales continued with at least three episodes this year.

And what was Japan doing? Driving the yen down, which is somewhat counter-intuitive based on the dynamics between the Chinese and Japanese economies, and considering that “China is Japan’s biggest trading partner with 26.5 trillion yen ($340 billion) in two-way transactions last year, from 9.2 trillion yen a decade earlier.”

The announcement is a warning that the devaluation of the dollar is not being taken lightly, implying that other arrangements will be made going forward. But ultimately someone has to consume the end products to keep the dream alive. What do they lack? A consuming base, and developing domestic demand runs into an almost insurmountable obstacle: Culture.

Thus the latest figures from the IMF regarding foreign reserves illustrates where the money is flowing while warnings are delivered.

According to Reuters, “the euro could become world's leading currency.”

The euro could become the world's leading currency in the next decade if leaders of the single-currency bloc succeed in tightening fiscal integration, European Central Bank policymaker Christian Noyer said in an article to be published in the Journal du Dimanche.

Maybe so, and I wouldn’t pretend to know exactly what the end game will deliver, and believe that the euro is here to stay in some form. But for the immediate future the dollar is the paper everyone wants, whether they admit it or not. And to shift capital out of the dollar into other currencies in a meaningful manner carries an economic cost that is not easily digested.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.