No obvious contender to replace greenback

OPINION: Most overseas economies are now officially out of recession, writes Tony Alexander this week.

Many have very tough roads ahead – most notably those with big government deficit and debt problems to combat, such as Greece, Portugal, Spain, Iceland, Ireland and Britain.

The United States also has a big budgetary problem, but unless something truly catastrophic happens (like late-2008) the federal government should comfortably be able to get the foreign funding needed for its large deficit. Why?

If you have been a follower of currencies in recent years you will know that there is a strong underlying theme regarding the US dollar one day being dethroned as the currency of exchange in international goods and the main currency central banks hold in reserve.

Predictions have flowed for years regarding traders and investors moving toward other currencies with this trend accentuated by the US becoming a smaller part of the world economy while building larger and larger foreign indebtedness.

The sticking points for ourselves when considering this movement have been two-fold.

First is the matter of when this movement would occur. There is no way of knowing.

But a couple of years ago when the US housing market was in freefall there was a general feeling that perhaps the time for a change was imminent. This accelerated with soaring oil prices and partly attributed to weakness in the greenback.

The second sticking point, however, calls into question the very idea of trying to pick when this shift will happen. It may never. That is because if the greenback is to be ditched one must have something to replace it.

There is no suitable candidate and the growing realisation of this has seen the euro fall to its lowest level against the greenback in over 10 months recently – because the previous main candidate to replace the dollar was the euro.

There are questions in play right now regarding whether the euro can survive the huge pressure Greece's economy is going to be put under to get the government's deficit under control – and similar pressure which is sure to hit some of the other EU members who ditched their currency a decade ago and adopted the euro.

A currency covering many disparate states or countries is fine as long as the members are prepared to sometimes sacrifice firm growth for the benefit of the group. Sometimes one's region or country may be weak but the entire group strong, in which case interest rates will be above what one's country may need but they will suit the larger grouping. The same for the currency.

We don't believe the euro will collapse, but the very questioning of the willingness of member countries to stay in means we still seem many years away from the greenback being abandoned in global trade for the euro.

The other candidate, the Japanese yen, is a complete non-starter. The country's population is shrinking and ageing rapidly, the government's debt as a proportion of gross domestic product is more than double that of Greece, and the manufacturing sector is under pressure as other Asian economies move up the sophistication ladder.

Hence recent greenback strength and hence some of the recent weakness in the New Zealand dollar against the greenback. Do we still think the kiwi will reach 80 cents?

The probability has declined, but we still see a good chance this will happen once the monetary policy tightening cycle kicks off here – probably in June. But if the US dollar remains firm we could see the New Zealand currency appreciate more than many people currently think against the likes of the British pound, the yen and the euro. Exporters should pay attention.

And against the aussie dollar? Limited gains for the kiwi are likely later this year with the aussie well supported by a strong economy.

» Tony Alexander is the chief economist for the Bank of New Zealand.

- © Fairfax NZ News