Value of the Dollar

The dollar, most surprisingly, saw a yearly gain against the Euro, although it fell against the Yen. The dollar was dropping like a rock last summer, but it is benefited in the global recession and financial crisis as an international safe-haven. However, fundamentals cannot be denied, and the relentless pressure against the dollar (rock-bottom interest rates, inflation of the money supply, deficit spending, trade deficits) will soon tell. Will the dollar hegemony end? It is hard to tell, and will only come about if conditions of hyper-inflation in the U.S. take hold. In fact, the entire world economic order is based on a strong dollar, and Japan and China (with export-based systems) would do just about anything to keep the dollar high. A switch away from dollar hegemony would only result from a total economic/monetary catastrophe, if Japan, China, and Saudi Arabia no longer saw fit to be tied to the U.S. economy. Such a turnabout would be remarkable, but is, quite frankly, not inconceivable given current trends. If Europe's economy emerges from recession, and if the ECB keeps their interest rate high, the stage is set for a switch to the Euro. But, if Europe stays in recession along with the U.S., and the ECB slashes rates to rock bottom like the U.S., no matter how bad the dollar gets, there will be nothing to switch to. The entire world will be dragged onto the roller-coaster of dollar hyper-inflation. Frankly, this scenario seems most likely.

Dec. 31 (Bloomberg) -- The yen and the dollar were headed for annual gains versus the euro as the first simultaneous recessions in the U.S., Europe and Japan since World War II encouraged investors to take refuge in the currencies. “Toward the end of the year, people were doing a flight to quality, flight to liquidity,” said Brian Kim, currency strategist at UBS AG in a Stamford, Connecticut. “The yen and dollar were the two candidates. Japan has more potential for money to go back into the country as the yield differential is erased across the board.” The yen was the best performer of 2008 among the world’s 16 most-active currencies against the dollar, while the rand was the worst, sliding 27 percent.

“The U.S. is being hit hardest by this crisis, and the economy remains weak,” said Stuart Bennett, a senior strategist in London at Calyon, the investment banking unit of French bank Credit Agricole SA. “While the dollar has been benefiting from a safe-haven status, sentiment is now turning against it.” The U.S. Dollar Index traded on ICE futures in New York, which tracks the greenback against the euro, the yen, the pound, the Swiss franc, the Swedish krona and the Canadian dollar, fell this month after the Federal Reserve cut its benchmark interest rate to a range of zero to 0.25 percent for the first time and shifted its focus to debt purchases to revive the economy.

The dollar fell the most against the yen in more than two decades in 2008 on speculation the Federal Reserve’s zero interest rate will undermine demand for the greenback. The dollar traded at 90.76 yen at 9:26 a.m. in New York, compared with 90.34 yesterday. It has fallen 19 percent this year, the most since 1987. Demand for safety will support the dollar in the first half of 2009, Kim said. He forecast the dollar may strengthen to $1.25 per euro and rise to 95 yen in the next three months, compared with median estimates of $1.25 and 90 yen at the end of the first quarter, according to analysts in a Bloomberg News survey.

The U.S. currency gained 0.7 percent to $1.3959 per euro from $1.4057, extending its 2008 advance to 4.5 percent. The euro dropped 0.2 percent to 126.69 yen from 126.97, extending its annual decline to 22 percent. The ECB cut its target to 2.5 percent, 1.5 percentage points lower than at the start of 2008, with some policy makers indicating they may be reluctant to lower borrowing costs again next month.

The euro was poised for its biggest rally against the pound since the 15- nation currency’s 1999 debut, trading within 2 pence of parity, on speculation the recession in the U.K. will deepen. The euro declined 2.1 percent to 95.56 British pence from 97.57 yesterday, when it reached a record high of 98.03 pence. Europe’s currency has gained 30 percent versus sterling this year, the biggest gain since the euro’s inception. The euro surged against the pound in 2008 after the Bank of England reduced its benchmark interest rate by 3.5 percentage points this year to 2 percent to limit the fallout from the global financial crisis.

The Australian and New Zealand dollars completed the biggest annual declines against the dollar since they started trading freely in 1983 and 1985, respectively. The currencies in 2008 reached their highest levels against the U.S. dollar in more than 20 years before sliding in tandem with commodities, which account for more than half the countries’ exports. Oil prices fell yesterday, contributing to the steepest annual drop in raw-materials costs in more than half a century. Australia’s dollar was at 69.24 U.S. cents and has slid 21 percent this year. New Zealand’s dollar traded at 57.99 cents and has tumbled 24 percent in 2008.

The Australian and New Zealand dollars have slid 36 percent and 39 percent, respectively, against the yen this year as a global economic slump and $1 trillion in credit-market losses prompted investors to cut so-called carry trades. In a carry trade, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the two. The risk is that currency market moves erase those profits. Australia’s benchmark rate is 4.25 percent and New Zealand’s rate is 5 percent, compared with 0.1 percent in Japan.