Dollar to stay as reserve currency

The credit downgrade of the United States could depress the dollar’s value but the greenback is expected to remain the world’s reserve currency in the absence of another alternative for now, according to a key Saudi bank.

National Commercial Bank (NCB) said the downgrade of the US, the world’s largest economy should theoretically raise the borrowing cost of the government to rates higher than other AAA countries like Germany.

“This, in turn, should push down the dollar's value relative to other currencies of strong economies,” NCB said in a study.

“The size of the US economy and its treasury market and the dollar's status as a reserve currency make it impossible to find a historical parallel for the current situation. However, being the world's reserve currency, the US dollar now appears inconsistent with an AA+ rating.”

NCB said the longer-term effects are driven primarily by whether international markets will eventually also downgrade the US. “Consequently, the biggest impact should be through the effect on the US dollar as a reserve currency.”

It noted that with China alone holding more than $1.2 trillion worth of US debt and Japan nearly $900 billion, any questioning of US's ability to pay its debts should “unnerve the global financial system.”

According to the study, foreign investors have supplied nearly 40 per cent of non-financial credit creation in the US over the past few years.

“Ultimately, the downgrade could increase diversification away from the US assets…..therefore, an increase in the pace of diversification should have a negative impact on the dollar and also would be an economic drag on the US, as domestic savings would have to rise to pick up the slack.”

In a report published this week, a Kuwaiti bank said a fall in the US dollar could fuel inflation again in the six Gulf Cooperation Council (GCC) nations as was the case in 2008, when their consumer price index soared to its highest annual average because of the lower dollar and domestic factors.

“GCC countries are heavily reliant on imports and the weakness in the US dollar will potentially aggravate inflation in member states by pushing up cost of importing goods to the region,” Global Investment House (GIH) said.

“The GCC will not only be exposed to its currency dropping against other currencies… it will also be exposed to cost push inflation as well. The downgrade will undoubtedly increase pressure to de-peg the GCC currencies so as to contain inflationary in the region although it is a difficult decision to be made and one which involves other important factors that need consideration.”

GIH said GCC currencies with the exception of Kuwait remain fully vulnerable to the risk of weakening dollar given the peg to the US currency.

“Although the Kuwaiti Dinar is the only currency in the GCC linked to a basket of international currencies it is believed to be heavily weighted towards the dollar, placing it more or less in the same position as the other GCC currencies.”

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