OPEC Bulletin January 2009OPEC Bulletin February 2009OPEC ...

When the financial crisis reached its height in 2008, it
quickly became clear that currencies would play a leading
role in the subsequent time after. Due to the large amounts
of money spent to stimulate the economy and bail out
the financial sector, a significant impact on the money
supply, and as a result currencies, had to be expected.
The bailout of companies is, for the time being,
over. However, stimulus spending needs to be gradually
unwound and this will again affect the money supply —
along with loose monetary policy — with volatility in the
currency markets set to persist.
These fluctuations have led to concerns that some
governments may be actively trying to devalue their currencies
to gain a competitive edge with one observer
coining the phrase “a race to the bottom”.
To allay fears, at the last G20 meeting in 2010, the
respective countries released a public statement to
emphasize that “there will be no competitive devaluation”.
All of this has once again brought the subject of
the value of the US dollar back to the forefront and the
Federal Reserve, as its keeper, too.
Understanding the Federal Reserve is not a science.
Information is very limited, especially when compared
with other central banks, and historical data is not of much
use because more times than not interest rate changes
were not justified by economic fundamentals.
For example, in the lead up to the internet bubble burst
in 2000, most observers expected the Federal Reserve to
increase interest rates because the economy was showing
signs of overheating. But it decided to continue cutting
them to record lows.
Unfortunately, now, more than ever, nations who have
to deal and keep significant savings in dollars, such as
China and OPEC Member Countries, are interested in the
Fed’s actions because the value of the dollar seems to
be on a downward trend.
With no viable substitute there are genuine concerns
with regards to the dollar’s role as the world’s reserve
currency, a role that should entail exhibiting long-term
stability. Estimates vary, but one dollar today is worth
between 40 and 45 cent of what it was in 1980.
Before the financial crisis, expectations for the fall in
the value of the dollar reached a new high as the value
of the euro kept rising. In fact, it was being pepped as
the new reserve currency. It is indeed an extraordinary
reversal of fortune to reach a point where, instead of talking
about the euro’s dominance, its very existence has
been discussed in recent months.
Shouldering the burden
This debate aside, there are now legitimate questions
about the finances of some euro zone countries. Germany,
as the euro zone’s de facto central banker, has shouldered
a disproportionate amount of the burden to prop up the
currency in the past months. Its efforts will have to continue
now that the finances of smaller member countries,
such as Greece, Ireland and Portugal, have highlighted
those of the larger members, including France, Italy and
Spain, who also have a significant debt burden.
For example, Ireland, with a government deficit of
14.3 per cent, and Portugal, at 9.4 per cent, are most at
risk, while the larger members, like Italy with 12 per cent,
Spain with 11.2 per cent, are also in a precarious position.
When examining these percentages one has to bear
in mind the Euro Stability and Growth Pact (SGP) which
stipulates that euro zone member governments can have
annual budget deficits no higher than three per cent of
their respective GDP (this includes the sum of all public
budgets, including municipalities, regions, etc).
Fluctuations between the euro and US dollar will continue
in 2011 because, whatever happens in Europe, they
will need to do something to increase creditor confidence
and their actions will constrain economic activity.
This does not necessarily mean that dealing with
the debt burden will put a break on the current economic
recovery, but it certainly limits its potential.
Unemployment remains stubbornly high, governments
are trying to reduce spending and consumers have yet
to return to pre-financial crisis spending patterns.
So while there can be no doubt that a recovery is
underway, the combined effect of the aforementioned
factors will continue to exert a significant lag on economic
activity.
One should also note that large debt burdens can
produce very fluid economic situations in the sense that
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