Will The US Dollar Remain As The World's Reserve Currency?

Many commentators are questioning whether the US Dollar will remain as the World's Reserve Currency. Until the end of World War II the Pound Sterling had its pride of place as the World's Reserve Currency, till 1945 when the US Dollar emerged as the key currency of the world's financial system.

Let us look at a brief bit of currency history:

Prior to 1914 Britain managed its financial systems in a saintly way and did not abuse its privileged position at the centre of the world's financial system, generally running balanced budgets and current account surpluses. Sadly, the same cannot be said of the United States – since 1981 the US has run huge current account deficits. Initially, this did not matter because the US has substantial foreign assets to offset foreign obligations. The result now is that the US has become the world's largest net debtor.

There are definite risks to the US Dollar continuing as the world's reserve currency, primarily because of a dangerously rising US Fiscal Deficit. This year the Fiscal Deficit is likely to reach US$2 trillion. The US's easy way out of this problem is to print more money, which will result in much higher inflation over time. Possibly a rise in the gold price from US$660 to about US$950 is evidence of this as well.

The Federal Budget Office projects that Federal debt will increase from 41% of GDP at the end of 2008 to 82% in 10 years time, despite government intervention.

Inflation As A Cure

Although there are many mainly unpopular and unlikely ways [such as strong economic growth and consumer spending, raising taxes and reduction of government spending] for the US to extricate itself from its fiscal morass, the problem is that the only workable way to reduce the budget deficit is by inflation - this will erode the value of liabilities such as the national debt while asset prices will increase. Inflation is not expected to rise in the near term but once world economic growth resumes, it could return with a vengeance. This is reminiscent of the 1970s when inflation rose and the gold price spiked and this is not good news for the US Dollar.

Information within this article sourced from Allan Gray's Quarterly Commentary, 30 June 2009.

This does not mean that one should not invest in US Dollar based funds. The philosophy to follow is to choose the right fund mangers that invest in shares of companies that trade at significant discounts to the actual intrinsic value of the business. With the view that the share prices of such companies will eventually appreciate to reflect the intrinsic business value. Although timing of the price move is uncertain, investing in such companies with a three- to five-year investment horizon should provide superior returns and reduced risk of loss.

It is for this reason that Silke Financial Services prefers using portfolios that are actively managed by portfolio managers, who have the ability to geographically and currency-wise, look for opportunities when they arise and have the flexibility to move around the world's markets at appropriate times.

Silke Financial Services - skilled risk and investment strategy consultants that provide a unique service offering not available elsewhere in the marketplace.