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US dollar: Haven or hell?
Thu, 10 Mar Pre-Open

The 'haven' status of the US dollar seems to be on the wane. Earlier, a flight to the greenback was usually triggered by a global shock or future uncertainty. Dollar was the safe asset for the risk-averse investor. Now the tables have turned. Short positions against the dollar have increased tremendously. All this thanks to the US' widening deficits and the extravagant monetary policies.

Several other factors are also playing out against the greenback. One is, of course, the rising crude oil prices. Now how does this affect the dollar? Higher oil prices will lead to a transfer of funds from oil-importing countries to the sovereign wealth funds of oil-exporting nations. And these funds typically keep a low quantum of their assets in the US markets. Secondly, some recovery is being witnessed in the euro. There is an expectation of interest rate increases in Europe to combat the rising inflation in the region. The US, on the other hand, seems too bent on its growth mandate and may let inflation go for a toss. It wouldn't be too surprising if it goes ahead with a third round of quantitative easing.

Over and over again, the dollar's status as a reserve currency has been challenged. It is quite an old debate now. Any further weakness in the dollar is going to have far-reaching effects on the rest of the world economies. Let's take the case of China for instance. Some recent figures from the US Treasury are quite shocking. China's holdings of US Treasury securities at the end of December 2010 were a whopping 30% higher than last year. To give you the exact number, China held US Treasury securities worth US$ 1.16 trillion compared to US$ 0.89 trillion a year ago. Now this is just one component of China's reserves. The total dollar holdings are over US$ 2.75 trillion. One can imagine the jitters that Chinese policymakers must be feeling over the uncertainty surrounding the dollar.

A slight change in George Michael's celebrated song would sound apt for the situation:

Time can never mend the careless mistakes of a good friend...

To the heart and mind, ignorance is kind...

there's no comfort in the truth...

pain is all you'll find...!

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