A better way to play the US dollar

published 13 October 2009

The dollar looks just about dead. The US is running a massive trade deficit, has an almost unfeasibly large budget deficit and offers basically no yield at all to anyone dumb enough to hold its currency. It is also still in recession and suffering from high and rising unemployment so the odds of interest rates rising to a level that might make the dollar attractive to international investors are pretty low.

But even worse than all that, rumours have surfaced (as they do every couple of years) that the Gulf states are planning to start pricing oil in a currency other than the US dollar. If that were to happen and one day it probably will it would deliver quite a blow to the dollar's status as the only real global currency, to say nothing of what it would do to demand for dollars.

Shorter term, however, Australia just this week hammered another nasty nail into the dollar's coffin by in what everyone is referring to as a "shock move" shifting interest rates from 3% to 3.25%. It now looks like some of the other commodity-exporting countries, all of which have done less badly out of the financial crisis than the rest of us, will follow suit.

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That means there is even less reason to hold US dollars than before. Why get 0% on the currency of a failing country when you can get 3.5% by holding the currency of a country that appears to have managed to avoid the global recession entirely?

The upshot is that the greenback is taking over from the yen as the 'carry-trade' currency of choice for global speculators: with US interest rates so low, it makes sense to borrow US dollars, shift the cash into a better-yielding currency and pocket the difference. No wonder the dollar has fallen 12% (on a trade-weighted basis) since March .

But before you rush to join the dollar-dumping, remember what happened when this financial crisis broke in the first place: instead of fleeing from the dollar, investors fled to it. When the market got nervous, they suddenly saw the dollar as a safe haven. So, rather perversely, the semi collapse of the world's largest financial system turned out to be a positive for its currency. Whatever might happen a decade down the line, right now the dollar remains the world's reserve currency.

Also, remember what happened to the yen. As the subprime crisis unfolded, the yen carry trade reversed everyone sold out of risky trades and repatriated yen and the Japanese currency suddenly went from being stupidly weak to being stupidly strong. These days it is busy crushing whatever recovery there might have been in Japan (by raising export prices) and, at the same time, importing a degree of deflation (via lower import prices) that the country really doesn't need.

My point? Currencies don't move in straight lines, and when they move, they move very fast indeed. And we should expect a whopping snapback in the dollar relatively soon. When stock markets fall and investors take fright (which I still think they will see last week's column), the dollar will rise again.

I'm not sure that most of us should actually be doing anything about this. We might use a small amount of money to speculate in foreign exchange markets but, in general, we need to keep our assets in the same currency as our liabilities (these being our current debts and our future spending obligations).

However, if you are particularly bullish on the dollar or have reason to hold significant amounts of cash in dollars, it isn't necessarily the US dollar you should buy, or so says Edward Cartwright of LGT Capital Partners.

Instead, you should buy the Hong Kong or Singaporean dollar. Why? Because both are currently pegged to the US dollar but may offer more upside than the US dollar: if Asian growth keeps moving faster than US growth (which at the moment at least looks likely), these countries won't be able to cope with continually importing the US's loose monetary policy (they'll need tighter monetary policy to hold off inflation). That means the pegs could break and the Asian dollars move up faster and further than the US dollar ever will again.

Finally, a word on the pound. I wrote here about six weeks ago that I expected it to strengthen against the euro. That isn't a call that has gone particularly well since. But I am going to stand by it.

Things are bad in the UK. We have horrible deficits and we have very loose monetary policy, both things currencies hate.

But, on the other hand, we don't have responsibility for Spain; we aren't embroiled in Latvia's debt crisis; we aren't attempting to make monetary policy for Italy; and we don't share a currency with Ireland. The fact is that the EU countries are all stuck in varying different stages of recession. Yet it can only have one set of monetary policies at once. In the end, they will have to be set to help the weakest of the economies. So far, it doesn't seem that the value of the euro is reflecting that. If it were, a coffee in Paris wouldn't cost £3.50.

This article was first published in the Financial Times.

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.