GOIH Quantitative Finance Group: Is the Sun Setting on the Dollar as the Reserve Currency?

Will the U.S. Dollar continue to be the reserve currency of the world? That is will most of the major commodities be priced in US Dollars forcing a purchasers to sell their currency and purchase Dollars to pay for imports? The Dollar is at an all time low against most of the major currencies especially the Euro currently trading at € 141.11 to the Dollar. Because of the subprime crisis and the credit market freeze up the Fed had to step in and prematurely cut its primary policy tool, the Fed Funds rate by 50 bps. This cut caused downward pressure on the dollar due to interest rate differentials between the Dollar and the other major economies of the world.

Dollar denominated assets immediately declined in value with the interest rate cut, and commodity prices increased thereby causing a forward looking increase in inflation due to the increase in import price primarily in energy and basic metal raw materials.

If the Dollar is no longer the reserve currency of the world, and the Euro ascends to the top, then the US is in real economic trouble. What this will mean is that the US will now have to sell the Dollar and buy the Euro to pay for imports, especially oil. Causing further decrease in the value of the Dollar and increase in the price of imports, causing increase in inflation, causing corporate profits to decrease, causing the equity markets to decrease, causing a recession, causing the Fed to continue to lower interest rated, causing the spiral cycle to run its course.

What is the Defining Act to Cause the World to Refuse the Dollar in International Commerce?

Lack of confidence in the economic fundamentals of the US will be the deciding factor of whether the Dollar loses its influence in the world. The economic fundamentals of the financial sectors relative to the general economy primarily decide the policy initiatives taken by the economic establishment to drive the economy. The last Fed rate cut will have no effect on the average consumer who cannot meet their mortgage payment or to the builder who over built with the expectation that the subprime mortgage would continue.

The largest sector of the economy, home building cannot be exported into a low cost labor market, nor can the supply of homes be exported and profit from the falling Dollar. The domestic demand is insufficient to consume the excess supply existing in the market causing a further price drop to clear the market of the excess inventory, estimated at a 48 month supply.