2009: A year leading to emergence of a post-dollar hegemony era?

Syed Shadman Rahim

THE year 2009 was a year of transition for the global markets. The year started with extremely pessimistic view about global outlook and concerns about the stability of the financial system as a whole. Equity, commodity, credit and currency markets reached a significant bottom in March. Since then there has been a steady recovery of all asset classes. Despite continued job losses in the U.S. there has been a rising optimism across the globe about an incipient recovery. However, the year seems to have ended with renewed concerns about quality of sovereign credit, particularly in light of the Dubai debt debacle.

Till March as the credit spreads widened, very large carry trade financed positions were covered causing a "margin call" of sort across all asset classes. This forced liquidation resulted in short-term dollar strength as there was a flight to safety from risk assets to Treasury instruments. It is this contraction of credit, this rapid de-leveraging that caused a collapse in equity, commodity and emerging market assets. Dollar and Yen got strengthened as the yen carry trade un-winded and investors at one point even paid to have the safety and liquidity of short-term T-Bills.

However, this strength in U.S. Dollar or in Japanese Yen was not due to relative fundamental strength of these currencies. What followed was the biggest government-financed bailout in human history. The US Federal Reserve quadrupled its balance-sheet in efforts to rejuvenate the credit markets. This massive flood of liquidity was part funded by increased foreign borrowing but more controversially through "quantitative easing". Fed Funds Rate was lowered to a historic 0% in order to increase liquidity in the financial system. Billions more were spent on bailouts of large financial institutions. Government guarantees and various Keynesian spending schemes were devised. By mid-year this massive flow of liquidity started to reflate paper asset prices and there was a return of risk appetite. Given the worsening employment situation consumer demand suffered in developed economies. The real estate market in the U.S. also didn't recover. So equities, commodities and other "distressed debt" paper attracted most of the liquidity. Emerging markets also made a remarkable comeback, outperforming the developed markets by a wide margin. Oil prices made a strong recovery. Gold, cotton, sugar and copper prices made new highs. Credit spreads also narrowed to more normal ranges.

This financial recovery and a flurry of relatively positive data gave birth to the Fed Chairmen Bernanke's "green shoots" notion of a nascent global recovery. But as economists are starting to extend their forecasts through 2011, the results don't look pretty. Jan Hatzius, chief U.S. economist at Goldman Sachs, forecasts that the "jobless rate will rise to 10.75% by the middle of 2011 from 10% now." An absurd term "jobless recovery" is being bandied about. But a structurally high unemployment in the U.S. and Europe only portends anemic growth for years to come. This reality is sinking in slowly but surely. There is now a growing concern that perhaps all that has happened is a transfer of private risks from financial institutions to government balance-sheets through debt-driven bailout efforts. Quality of sovereign credit is worsening. Last year's Iceland bankruptcy reminded the world of such a possibility. But now with Dubai falling behind on its massive debt burden and Greece getting downgraded, the possibility of a sovereign default within the Euro zone and the subsequent contagion across the globe is becoming very real. Dollar showed continued weakness since March, slowly sliding against all other majors. Euro/USD rose from 1.25 in March to a year high of 1.51 in November. GBP/USD rose from 1.38 in March to 1.70 August. Central banks and large dollar holders are trying to reduce dollar exposure both through real diversification as well as through synthetic means. Most profound of such moves will be Asian central banks' plan of diversifying their massive dollar holdings to a basket of other currencies. Chinese central bank has created Yuan swaps with Brazilian, Malaysian, Indonesian and Thai central banks. They have also bought an initial 50 billion dollar tranche of IMF SDR denominated debt. Gold prices have risen from a low of 810 to 1214 an oz. There seems to be a growing consensus on the need to explore alternatives to the U.S. Dollar as the only international reserve currency. If and when it happens, this may turn out to be the most significant after-effect of the Global Financial crisis. In that sense 2009 may mark the epoch of an era.

(The writer is Associate Director, FM Sales, Standard Chartered Bank)