During the height of the financial crisis, the U.S. dollar spiked as investors fled to the quality and safety of what is considered to be the world's reserve currency. Peaking in March 2009, the dollar has had but one strong rally since. That occurred in late spring 2010 as worries that the U.S. might experience a double-dip recession heightened. As equities were sold investors once again plowed into the valued destination of the dollar. In both instances the dollar's store of value benefited from the "risk off" trade that imposed itself on other, seemingly less stable and riskier instruments.
That was then. Today, in the midst of rising tensions in the Middle East and concerns about escalating oil prices, the dollar has faltered. Does this mean investors have now taken a jaundiced eye toward the United States and the strength of its currency?
Because of the circumstances surrounding this particular event, we think the view is justified. The politics of a regime change that canvases an area that is strategically important to the United States is not necessarily a welcome development. One of the strength's of the U.S. dollar is the solidity of its assets both home and abroad. Given the powder keg that rests underneath the turmoil in Libya, let alone the potential for it to seep into Yemen, Bahrain, or even Saudi Arabia, it is reasonable for market participants to interpret this as an unsettling development for the U.S. political agenda.
In addition, and perhaps more important, is the economic consequences of a scenario in which already high oil prices spike further on a supply shock or other disruption that is not just transitory in nature. Given the U.S. is the world's largest net oil importer the risks are elevated. An extended period of high energy prices would have an impact on growth and likely slow the economy. That would be an unfavorable adjustment at a time when the U.S. recovery is delicately morphing into a durable expansion and the hopes of politicians and the underemployed is for that to lead to improvements in the beleaguered job market.
It is estimated that every $10 increase in the price of a barrel of oil is equivalent to $0.25 cents at the gas pump. Just since the end of November, West Texas crude has jumped $20 a barrel raising gas prices in the U.S. by approximately $0.50. Another $20 to $120-$125 a barrel would push the U.S. market close to $4 a gallon on a national basis, a troubling level for consumers. In fact, it was in the summer of 2008 that gasoline prices last breached this psychologically important level. The economic let alone behavioral changes induced by it had a meaningful contribution to the recession that ensued.
Even at roughly $104 a barrel today, not the $147 reached in 2008, the U.S. Federal Reserve's monetary initiative to prime growth to establish price stability and full employment might be jeopardized. Therefore, the Fed may be inclined to err on the side of maintaining its exceedingly dovish posture for longer than intended otherwise, further pressuring the dollar's value against other currencies.
With the President of the European Central Bank, Jean-Claude Trichet, openly admitting that a rate hike might be coming as soon as a month from now, while at the same time governors' at the Bank of England are turning more hawkish, the dollar has already been stumbling. Now with concerns that the potential diminution of economic activity caused by the consumption "tax" that higher oil prices apply to U.S. consumers, the dollar has found a new foe to combat.
The inevitability of the dollar's diminishing role in the world's community of foreign exchange trade is probably inarguable. However, it need not be thought of in that context as so much a U.S. failing as that of the rest of the world catching up. Particularly, when considered against the fastest growing economies of the world led by China. At the same time, we would not be so quick to conclude that the dollar has lost its step. The strength of the U.S. among many things is its resiliency, its ability to attract global capital, its military, its political stability, and its economic output that still dwarfs all other countries. While certainly not without its wrinkles, the U.S. dollar - a currency that represents more than 60% of the world's reserves - has not yet lost its place.