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Weak Dollar Illusory as Correlated Trade Shows Gains (Update1)

Feb. 8 (Bloomberg) -- For all the concern over the $1.6 trillion U.S. budget deficit and record debt load, the dollar is as valuable now as 35 years ago.

Measured against a basket of currencies from the Group of 10 nations proportioned by how they trade against each other, the greenback is up about 3 percent since 1975, according to Bloomberg Correlation-Weighted Currency Indexes. That was four years after the Bretton Woods agreement, set up in 1944 to link currencies to the price of gold, collapsed. The U.K. pound has dropped 34 percent and the Canadian dollar has fallen 6 percent.

The U.S. dollar gained 6 percent since November after losing 12 percent in the first 11 months of 2009 as measured by the Bloomberg index. Barclays Capital and Morgan Stanley say the U.S. will grow faster than the rest of the developed world this year and 2011. At the same time, Europe faces worsening finances in Greece, Spain and Portugal, Japans economy is struggling and concerns about valuations in emerging markets are increasing.

To quote Mark Twain, the reports of the dollars demise have been greatly exaggerated, said Win Thin, a senior currency strategist in New York at Brown Brothers Harriman & Co., which manages about $40 billion in assets.

Rising Demand

Nowhere is that more evident than in the market for U.S. Treasuries. The amount of Americas government debt held by investors outside the U.S. rose 17 percent to $3.6 trillion in 2009 through November, according to the Treasury Department.

Purchases may continue to rise as investors seek refuge from growing sovereign credit risk in the euro area. The dollar will benefit from relative liquidity of the U.S. Treasury markets, Barclays Capital currency strategists led by David Woo in London said in a Feb. 5 report.

Barclays Capital economists said in a report the same day that U.S. gross domestic product may grow 3.6 percent this year, versus 2.5 percent for the developed world, and 3.1 percent in 2011, compared with 2.6 percent elsewhere. Japans GDP may expand 1.9 percent this year, and the euro zone 1.3 percent, they said.

A day earlier, strategists at New York-based Morgan Stanley boosted their dollar forecast, saying it will strengthen to $1.24 per euro by year-end from its previous estimate of $1.32. It traded at $1.3638 today. The firm sees the U.S. currency gaining to 109 yen from 89.25 today, and rallying to $1.49 to the pound from $1.5612.

Reserve Currency

Investors and traders predicted last year the dollar would lose its position as the worlds reserve currency, which means its the first place central banks look to park their cash.

With all the concerns about the problems with the U.S. financial system last year, the banking sector in the euro zone looked a bit more stable, said Robert Sinche, chief strategist at Lily Pond Capital Management LLC in New York. That created a sense of the euro as an alternative to the dollar.

Central banks that disclose breakdowns of their reserves bought a record $60 billion worth of euros in 2009s second quarter, more than half of their new cash in the period, based on International Monetary Fund data adjusted for exchange-rate changes using methodology developed by Barclays Capital.

They then reversed course, putting 15 percent of new reserves, or $17.8 billion, into euros in the third quarter, the smallest share of any period in which their reserves grew since early 2008. Central banks put 45 percent, or $52 billion, into dollars, up from 36 percent.

Rally by Default

Rather than a referendum on the U.S., the dollar may be rallying by default. Nouriel Roubini, the New York University professor who predicted the credit crisis, said on Feb. 4 that the greenback may weaken for the next three years.

Moodys Investors Service said last week the U.S. governments Aaa bond rating will come under pressure unless additional measures are taken to reduce budget deficits projected for the next decade. The ratio of government debt to GDP and revenue increased sharply during the seizure in credit markets and recession, Moodys said.

If the current upward trend in government debt were to continue and become irreversible, the rating could come under downward pressure, said analysts led by Steven Hess, a senior credit officer at Moodys in New York.

The Obama administrations plan to offset spending by more than $1.2 trillion over 10 years showed larger deficits and higher debt levels than in the original budget, Moodys said. The ratio of debt to GDP in the U.S. will continue to expand, reaching 76.5 percent in 2019 compared with an earlier forecast of 70.1 percent, Moodys said.

Treasury Secretary Timothy F. Geithner said in an ABC News interview broadcast yesterday the U.S. isnt in danger of losing its Aaa rating.

Absolutely not, Geithner said, when asked whether a downgrade is a concern. That will never happen to this country.

A Better Bet

The U.S. Office of Management & Budget said Americas budget deficit will fall each year through 2014, to $706 billion from $1.56 trillion in 2010, as borrowing needs drop to $814 billion from $1.75 trillion.

Under stress, people trust the U.S. to do the right thing, said Sebastien Galy, a currency strategist at BNP Paribas SA in New York. The U.S. is a better bet.

A global reserve currency must provide investors with the ability to invest, which requires liquid markets, and few capital controls, according to investors. Chinas yuan cant replace the dollar because it isnt fully convertible and doesnt float freely. The euro region and the markets for commodity currencies, such as the Australian, New Zealand and Canadian dollar, dont have enough trading to absorb the amount of cash the reserve banks hold.

No Alternative

There is no alternative to the dollar, so its status as a reserve currency cant be under threat, said Adam Boyton, a senior foreign-exchange strategist at Deutsche Bank AG in New York.

The dollars preeminence will remain intact, as it continues to be the most widely used currency in business and finance worldwide, the Federal Reserve Bank of New York said in a report released Jan. 5. Some $580 billion in banknotes, or 65 percent of all bills in circulation, were held outside the U.S. as of March 2009, according to Fed data.

The greenback has an 86 percent share of the foreign- exchange market, more than twice the euros 37 percent. Its share of the international debt market is 39 percent.

The international role of the dollar remains substantial a decade after the introduction of the euro, and despite changes in the value of the dollar and the financial turmoil that began in 2007, Linda Goldberg, a vice president at the New York Fed, wrote in the report.

Relative Deficits

While the Congressional Budget Office expects Americas debt to reach 65 percent of GDP in 2010, that would still be below the 77 percent of GDP the European Commission expects for Germany, the U.K.s 80 percent and Japans 180 percent.

I would want to stay away from the euro, the euro zone and some of the emerging European currencies, Michael Gomez, the co-head of emerging markets at Pacific Investment Management Co., said on Feb. 4 at a conference in Moscow. The Newport Beach, California-based firm manages the worlds biggest bond fund.

At their meeting this weekend in Iqaluit, Canada, Group of Seven finance ministers pledged to press ahead with economic stimulus measures. Canadian Finance Minister Jim Flaherty told reporters that we need to continue to deliver the stimulus to which we are mutually committed and begin looking at exit strategies to move to a more sustainable fiscal track.

Yen Gains

Rather than using a weighted average of exchange rates based on trade data, which is reported on lag and subject to revision, the Bloomberg Correlation-Weighted Currency Indexes calculate weights based on variances in exchange rates.

The indexes have a start date of Jan. 2, 1975, and a base value of 100. The dollar index rose 0.2 percent to 102.79 today and the yen index climbed 0.2 percent to 396.22. The Swiss franc index declined 0.2 percent to 270.57 and the euro index slipped 0.1 percent to 107.49. The index for the euro replicates the German deutsche mark before 1999, when Europes common currency started trading.

The New Zealand dollar index fell 0.1 percent to 50.20 today, the Swedish krona index was little changed at 52.83 and the Australia dollar index dropped 0.2 percent to 64.09.

Though the dollar is the worlds reserve currency, it doesnt affect the movement of foreign-exchange rates as much as the euro, the indexes show. Since the euros creation, its correlation to other G-10 currencies has steadily risen, overtaking the dollar in 2004 and all others by December 2008.

To contact the reporter on this story: Ben Levisohn in New York at [email protected]

Last Updated: February 7, 2010 22:51 EST