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Investment Strategy

A New Morning in America

By Elliott H. Gue, on Feb. 22, 2014

And that brings me to one of the most pernicious rumors spread by the doom-and-gloom advertisements that apparently work so well: Despite what you may have heard, the US dollar remains the world’s preeminent reserve currency and the preferred global store of wealth.  

As of the most recent quarter, the US dollar accounted for 61.2 percent of the world’s US$6.1 trillion in allocated foreign exchange reserve holdings. In 1995, the ratio was about 59 percent.

Over the past 18 years, the dollar’s prominence as a reserve currency has increased.

And what are the alternatives to the dollar?

The EU economy is roughly the same size as the US, and the euro trades with enough liquidity to serve as a reserve currency. At present, the euro accounts for slightly less than a quarter of total allocated reserves, up from about 20 percent in 1999.

But the euro has serious flaws. Although the countries in the eurozone share a currency and the European Central Bank (ECB) sets the region’s monetary policy, each member sets its own fiscal policy and issues its own bonds.

While Germany and other EU member states have a history of responsible spending and low public debt, Italy, Spain and Greece find themselves saddled with high government debt after long histories of running large public-sector deficits.

Over the past few years, Greece and Italy’s borrowing costs have spiked relative to the yields on bonds issued by Germany, Holland and other fiscally prudent member states.

The region’s credit crisis has forced some nations to accept painful fiscal austerity as a condition of receiving EU support.

There are legitimate fears that one or more EU member states facing painful spending cuts and soaring borrowing costs could eventually be forced out of the currency union.

Ultimately, the region may solve this problem by allowing countries to issue bonds backed by the entire EU. But these eurobonds are unpopular in Germany and other fiscally sound EU countries and remain years away.

Although the US dollar has its flaws, the euro won’t topple the dollar as the world’s main reserve currency until the EU tackles puts its own house in order–a task that’s easier said than done.

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