The New Reserve "Currencies"

“The intrinsic value [of the dollar] is zero,” says Dr. Marc Faber, “and that’s where it will go. Whether it will happen in five or 10 years time, nobody knows… I don’t believe in a new world reserve currency for the immediate future, but I believe that the U.S. dollar, after a near-term rebound that could last three-four months, will continue to depreciate.”

The dollar carry trade is surely one possible route to Marc Faber’s pinpoint prediction. Investors borrowing dollars at low interest rates (or shorting dollars) and then investing the proceeds in foreign currency-denominated assets (usually with higher yields or higher expected returns) place downward pressure on the dollar exchange rate and upward pressure on the foreign currency asset they are purchasing. As the dollar exchange rate falls, the effective cost of borrowing in dollars falls, and thus the incentive to devote more resources to the trade increases — people will tend to pile into the trade, to the point it eventually will become a ‘crowded’ trade, as the negative borrowing rate becomes recognized…

But here is the problem: As of 2008, the McKinsey Global Institute estimated the United States accounted for about 21% of global GDP, while U.S. capital market assets totaled one-third of the world’s $167 trillion in assets. In addition, roughly 65% of the total foreign exchange reserves of foreign governments are held in U.S. dollars, while the euro has the next highest share, at 25%.

Dethroning the dollar may take some time, given there is as yet no other nation in position to replace these mammoth U.S. shares of global economic activity and portfolio holdings. The euro may be the closest candidate, but there are enough questions about whether the one-size-fits-all monetary policy approach may eventually spur populist calls for the defection from the European Union of Ireland, Greece, Spain and other nations still struggling with serious economic weakness that this remains a long-shot candidate. The IMF’s special drawing rights (SDR) has been frequently named as another candidate, but the SDR is really a weighted basket of four currencies, with 44% of the weight placed on the U.S. dollar, so it is not much of a replacement for those seeking to reduce U.S dollar exposure at all…

Metals Price Increase

While we recognize real GDP growth has returned to much of the world, we doubt the advances in numerous commodities through mid-November (shown above) are entirely the result of stronger end demand for the products that require these commodity inputs. Rather, the ‘flight to real values,’ as Hayek termed it, appears under way as the reserve currency status of the dollar has been put into question, but no other fiat currency can take its place.