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King dollar, reserve currencies and financial panics

This is the global appeal of King Dollar, which could well rise another 20 per cent against the euro and emerging market currencies.

By Matein Khalid

Published: Mon 15 Jun 2015, 11:21 PM

Last updated: Wed 8 Jul 2015, 2:46 PM

Lord Keynes called it “economic seigniorage”, a reference to the feudal privileges of Norman noblemen (seigneurs) in Angevin/Plantagenet medieval England. Seignorage is the ability of a nation whose currency acts as the world’s reserve currency to extort financial rents from the rest of the world via running persistent trade deficits and devaluing its currency over time. For instance, the Roman Denari was the world’s reserve currency two thousand years ago but cheap finance enabled the Roman Imperators to fiscally devastate colonies in Hispania, Pannonia, Noricum, Gaul, Narbonne, Lusitania, Judea, Asia Minor (Anatolia), Illyria, Dacia, Helvetica and even Britannia.

The British pound was the world’s reserve currency a century ago as the City of London was the banker to a colonial empire on which the sun never set, even though it has gone into a multi-culti eclipse now that only the Falklands and Gibraltar remain. However, the politics of the Bretton Woods conclave proved that if Uncle Adolf’s Third Reich was doomed by World War Two, so was Sir Winston Churchill’s British Empire. The world’s reserve currency since 1944 has been the US dollar and Uncle Sam has the lender of the first and last resort in international finance.

Yet America abused its “exorbitant privilege”, as General Charles de Gaulle called it, after LBJ waged the Vietnam War and financed his Great Society welfare state via deficit financing and Tricky Dick ended Bretton Wood’s gold-dollar link. The US dollar has depreciated more than 90 per cent since the Federal Reserve was created lack when Woodrow Wilson was president in 1913. The US dollar has lost 40 per cent of its value since Alan Greenspan was hailed as the Maestro of central banking in 1987, weeks before Black Monday. “Our currency, your problem”, Nixon’s Texan treasury secretary taunted a world forced to own, trade, borrow and store wealth in dollars.

President Barack Obama’s alleged quote in the Bavarian Alps that the “strong dollar” is a problem for the world is actually true. Take the GCC; the plunge in oil prices means the GCC has lost $300 billion in petrodollar revenues. The 20 per cent rise in the US Dollar Index since April 2014 has affected the GCC’s tourism, property and share markets. Yet we are only in the first year in what could be a six-year US dollar bull market, akin to Reagan’s first term (1981-85) and the latter part of Clinton’s (1995-2000). If the euro falls to Wim Duisenberg levels, as I expect, the US Dollar Index (57 per cent euro-weighted) will rise another 20 per cent while Brent crude could well fall to $49. This means the GCC will face its worst deflation shock since 2008-09. Yet since the GCC currencies are pegged to the US dollar, monetary policy in the region will tighten as the Fed raises rates. The GCC currency pegs help explain the periodic boom bust cycles in regional stock markets, property and banking since 1999.

Robert Rubin, treasury secretary under Clinton, first articulated the “strong dollar” policy in the 1990s even if it led to the Mexican, Thai, Indonesian, Russian, Turkish, Argentine and Pakistani sovereign debt crises (okay, the Kargil war and the post-nuclear test sanctions are also to blame here). The US literally sucked in the world’s capital, thanks to Silicon Valley’s tech/Internet mania. Inflation plunged, as did US Treasury bond yields. Then came 9/11, the US invasions of Afghanistan and Iraq, the fiscal lunacy of the Bush era and Fed Zirp that culminated in the failure of Lehman and a global financial crisis. The US dollar surges in times of crises. Our currency, your problem. Uncle Sam wins game, set, match. Global sad sacks lose as usual.

So why has the US Dollar Index soared since last summer? Fed policy, Europe’s economic disaster, Crimea, Greece, Ukraine, post-Dodd-Frank/Volcker Rule liquidity shocks in debt markets, flight capital from a Middle East, China, West Africa and Russia in geopolitical stress, central bank panic diversification out of euros, yen, petrocurrencies like the Canadian dollar and South African rand. It is simply irrational not to invest in the US dollar in the world of mid-2015, as the ECB and Bank of Japan money printing accelerates, China slows to 25-year lows and deflation shocks devastate commodity exporters.

I remember my Econ A levels. Money is a store of value, a medium of exchange, a standard for payments, a unit of account. This is the global appeal of King Dollar, which could well rise another 20 per cent against the euro and emerging market currencies. This makes global financial panics certain in the next six months. Risk is a four-letter word. But so is ruin.


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