TOWER Insight: What Price the US Dollar?

Its position in this role was enhanced when US President Richard Nixon ended gold convertibility of the greenback in 1971, effectively destroying the Bretton Woods system.

This year concerns have mounted about the US dollar's stability as an international store of value and falling US dollar exchange rates have got a lot of people worried about the consequences.

The rout of the US dollar has several factors behind it:

• The US Federal Reserve has set the official Federal Funds overnight interest rate at between zero and 0.25% and repeatedly indicated it will be leaving that rate in place for an extended period
• At the same time the Fed has run a massive quantitative easing ("printing money") programme that has sharply increased US dollar supply
• The US Federal government has launched a huge fiscal stimulus program debt-funded by massive issuance of US Treasury notes and bonds

All these decisions by US government authorities have conspired to create conditions wherein the US dollar slips in value relative to the currencies of many other countries. Although the official US government line is that a strong greenback policy is in place, unofficially the benefits of a weak currency cannot be lost on the Americans.

For the US, having the greenback feeble for an extended time helps cut the debt burden of the fiscal blowout, while boosting exports, hindering imports, encouraging import substitution industries, and mitigating soaring unemployment rates. Signs of how the dollar's status has fallen include increased speculation that it will lose its reserve currency role. There have been reports - hotly denied - that oil producing countries are looking at moving away from the US dollar as the standard currency unit of crude oil pricing. Instead, a basket of currencies, including gold would be used, and a big surge in the value of gold has resulted as it comes back into vogue as a currency in its own right.

Investment implications include the return of global inflationary pressures, compensatory increases in bond yields, rising commodity prices (most commodities are priced internationally in US dollars), and popularity of hedge fund strategies that are short the US dollar and long the other currencies that are obliged to rise as the greenback sinks - particularly emerging market currencies.

Investment portfolio hedging strategies will need to take account of a greenback weaker for longer in the face of evidence that what American officials say about their strong greenback policy bears little connection with what they are doing to undermine its value in the US national interest.

As President Nixon's Treasury Secretary John Connally once said to an assembled group of foreign finance ministers, "The dollar may be our currency, but it's your problem!"

 Read the full TOWER September 2009 Portfolio here.