Can the US Dollar retain its Reserve Currency Status

As markets have gotten increasingly volatile in recent weeks and talk of Global Financial Crisis (GFC) Mark II gets louder once again with a default by Greece being likened to Lehman Brothers collapse in 2008, I ponder whether the safe haven status which the USA enjoyed back in 2008 and 2009 would be repeated a second time around.

Indeed it was an incredibly ironic situation to have the root cause of the GFC and the epicentre of the crisis being the USA and yet money poured into US Bonds and hence US dollars. There was of course method in this seeming madness. The overarching view of the market was that no matter how bad things were going to get for the USA in the GFC – the rest of the world would suffer a worse fate.

Had your timing been impeccable you probably made money buying the US dollar as the rush to US bonds snowballed. So much so that as you’ll recall the Yield Curve actually turned negative. People were paying the Federal Reserve simply to hold their money! However assuming your crystal ball wasn’t quite that clear and timing not so perfect it’s obviously been a lousy investment not just if you owned bonds on paltry yields but as the US dollar has weakened against most major currencies since the darkest days of GFC Mark I.

The point to this little walk down memory lane is to consider what your strategy should be in the event of GFC Mark II. The USA is not the same “tower of strength” (a term I use lightly and somewhat tongue in cheek) in 2011 as it was in 2008. The debt ceiling has been raised numerous times by Congress, structural unemployment is significantly worse and the housing market still a mess to name just three.

Furthermore it appears that China is concerned about its enormous exposure to the US dollar and may be positioning itself for an end to the US dollars dominance. There have been recent reports that China has been pushing for iron ore contracts in future to be settle in Chinese yuan not US dollars.

I’m sceptical that should GFC Mark II occur that the markets will view the USA and specifically the US dollar as a safe haven or as the world’s reserve currency so beware of expecting history to repeat and adjust your fx strategy accordingly.