Dollar’s Bottom May Be Near

12/11/2007 12:00 am EST

Focus: GLOBAL

Vivian Lewis

Editor and Publisher, Global Investing

Vivian Lewis, editor of the Global Investing blog, says there's universal pessimism about the greenback, but there's no real substitute as a reserve currency.

[The Federal Reserve's rate cuts have put] Smokestack America back in business.

The coming US export boom will favor big-ticket items whose prices will drop because US demand will fall when people have to stop using their houses as ATMs. And they will also drop because of the cheaper dollar. So, the Yankee clipper will again sail and sell to the world. That means foreign companies directly competing with US exporters of goods and services are likely to suffer.

Other countries, starting with Canada and Great Britain, have also cut rates. So, fund flows into their currencies will fall just as those to the dollar have.

But in fact, the fear of other rate cuts in other countries will keep foreign exchange markets on their toes. Because while US policy has been widely signaled, other countries have been more discrete. The likely beneficiary of the flight from the dollar is, of course, the euro.

Reserve switches out of the greenback into the euro have gone on for years. But clearly there are limits on how much switching there is, or nobody would be holding dollars at all.
  
Despite all the obvious risks, about 70% of trade today is denominated in dollars. And about 70% of the reserves of the surplus countries of the world are also denominated in dollars. I think that the level will not change much short term and will keep the dollar from falling much further.

The euro, which started out at 16% of reserves, is now at a full quarter. But it is not actually an either/or matter. There have been long periods of history when there were two or even three reserve currencies, like sterling, the French franc, and the mark.

Another big preserver of the dollar is the fact that it is the most liquid, most accessible currency on earth. So, it is the denomination of choice for the fruits of crime, much of which is kept in cash.

The most important point worth making is that trends reverse. When things have gone so far that everyone has clambered on board the trend, it has a nasty way of ending.

The Economist [recently had] a cover story on the collapse of the dollar showing the image of George Washington in goggles in an airplane with its wings on fire. That may mark a bottom indicator like the [notorious] "The Death of Equities" 1979 cover story in BusinessWeek.

Paul Macrae Montgomery created a contrarian indicator based on cover stories in popular magazines. He wrote:    
 
"When public awareness of an economic trend is at its greatest saturation, the trend is so extreme that it will soon reverse." 

Finally, who can take up the slack? Obviously the decline of reserve currencies has a geopolitical link. Can we write off American hegemony in the world? Where else will leadership come from in the next decade?  

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