The Greenback May Rebound
Maybe writing about what's ahead for the dollar in 2007 is a poor use of space. After all, according to recent calculations by the Financial Times, the euro-which turned five years old this month-is set to overtake the greenback as the world's most popular currency.
But not so fast, Old Europe. What's gotten lost in all the euro hype is that the FT's financial figuring applies to notes in circulation: cold, hard cash. When it comes to currency-denominated assets, the dollar is still king. The United States runs the largest stock and bond markets in the world, and 66 percent of global foreign currency reserves are denominated in dollars-some $2.1 trillion-compared with only 25 percent in euros, according to the International Monetary Fund.
Yet the almighty dollar tanked as 2006 drew to a close. Since mid-October, the dollar has fallen 6 percent against the euro. With widespread concern about the sustainability of the gigantic $800 billion U.S. trade deficit-which requires continuing megapurchases of dollars-some dollar bears interpreted the recent decline as the beginning of a long-awaited greenback collapse. Perhaps foreign central banks, flush with dollars, would begin to dump the dollar en masse.
Cashing out. Dixon Fung, a currency trader at MG Financial, has a simpler, more benign explanation. "Traders just finally realized that we are at the end of a Fed tightening cycle," he explains. Higher U.S. interest rates have served to counterbalance America's huge trade deficit by paying foreign investors more to hold dollars. Now, with growth having slowed and the Federal Reserve Board on hold and perhaps ready to lower rates-and with its European Union counterpart raising them-it seemed a good time to sell. And while the dollar could dip a bit more, don't expect a full-fledged rout.
"The dollar probably should head lower, but it probably won't," says economist Robert Brusca of Fact and Opinion Economics. He notes, for instance, that China has no interest in dumping dollars and thereby starting a panic that would seriously devalue its $700 billion in U.S. government bonds and other dollar-denominated assets. And growth in the EU is forecast to slow in 2007, making that region less attractive to investors. Indeed, the dollar has started to strengthen of late. A surprise Fed rate hike would help even more. While some countries, such as China and the United Arab Emirates, may continue to diversify their foreign currency holdings, "nothing is going to replace the dollar anytime soon," Brusca says.
This story appears in the January 15, 2007 print edition of U.S. News & World Report.