JOHANNESBURG (Business Day) -- The global financial system stores a lot of value in the U.S. dollar, but the world economy may gradually be diversifying into other currencies. With David Gracey from Nedbank Capital.
LINDSAY WILLIAMS: An article on the front page of the London Financial Times (FT) suggested that oil producers and other significant world players may be dumping the U.S. dollar. Dave, do you agree with that? Do you think people are fleeing the U.S. dollar?
DAVID GRACEY: I don’t think it’s quite that dramatic, but certainly we are seeing some diversification of reserves - last time I spoke to you we chatted briefly about it. Recently we’ve seen China’s official foreign currency reserves topping one trillion dollars - that’s a huge number of eggs to have in one single basket - and Opec has been making a noise recently about diversifying reserves. I don’t think it is reserves fleeing, but even a small amount of diversification in illiquid markets will have the effect that we’ve seen in recent weeks.
LINDSAY WILLIAMS: That Financial Times front page story today says: “The review from the Bank of International Settlements says that Qatar and Iran, whose foreign exchange policy has sparked widespread market speculation, cut their dollar holdings by U.S.$2.4-billion and U.S.$4-billion respectively.” In a day’s trading you probably do that amount before you have your bacon and egg sandwich in the morning, so that’s quite small, but the FT goes on to say: “Such shifts may be modest compared with the total assets held, but that provides a crucial indication on future thinking”. In other words people are saying the dollar is not the store of value it used to be, and that could trigger a tidal wave at some stage?
DAVID GRACEY: That’s exactly right. If your traditional buyers of dollars start changing or diversifying their reserves people start questioning their investment decisions, asking if perhaps they shouldn’t do the same. Bear in mind that the U.S. has to track roughly $2-billion a day in foreign capital just to fund their deficits - then you begin to see the reason why some people are questioning their decisions and why they might be diversifying their reserve holdings. It’s about sentiment, and if Opec, China, Russia, Brazil and India start questioning where their reserves should be the general market will follow that trend.
LINDSAY WILLIAMS: You’re a currency trader, and I’m a frustrated currency trader turned broadcaster, but you and I both know - not being political commentators or analysts - that there’s politics as well. Surely China, Russia and Opec all together could muscle out George W Bush?
DAVID GRACEY: Undoubtedly. I don’t think it’s a deliberate play. If you just look at China with central bank foreign currency dollar holdings of one trillion dollars - if something dramatic had to happen that could have disastrous consequences, with huge losses for them. It’s economically prudent to diversify that reserves holding. Any investment manager would advocate diversification - there might be a little bit of politics, but I think it’s just prudent investment quite frankly.
LINDSAY WILLIAMS: I’m always looking for a good story so I would say that George W Bush is probably on his knees at the moment - he’s had a dreadful mid-term election, his Iraq policy has been torn to shreds and is in tatters at the moment, and if he has ever been vulnerable in the last couple of years it’s right now - if the dollar starts to go and the U.S. economy starts to weaken he could even go before the end of his term. Currency traders are predatory - a few weeks ago with the Thanksgiving holiday the euro against the dollar was around 1.2950 or 1.30 and lots of orders were flying around in a thin market, and that’s when the dollar started to fall - are the hedge funds and currency traders now targeting the dollar, and could it get much worse?
DAVID GRACEY: We put a report out about two weeks ago - the dollar has been through 1.30 to the euro on two occasions, and that was late 2004 and early 2005. On both of those occasions it went to 1.3450 and 1.3650 and those are the levels that could be in the speculators’ sights. It depends now on future economic indicators coming out of the U.S. - what the interest rate outlook is, what the U.S. Federal Reserve says on Thursday - all of these things come into play, but certainly the dollar is vulnerable at this point in time and that’s based on pure economics. You mentioned George W Bush - there is no doubt in my mind that history will count against him as far as his economic policy is concerned. Everything is borrowing, tax cuts, deficits heightened - so I would foresee that those levels against the euro are certainly on the cards in the not too distant future.
LINDSAY WILLIAMS: Add to that the expensive U.S. foreign policy. Let’s look at the rand because that’s what we are really interested in at the end of the day - the dollar will boost the gold and platinum price, but where is the rand going to go? The rand against the dollar is currently around 7.04 - if the dollar continues to slide from here does that mean automatically the rand strengthens?
DAVID GRACEY: It’s a slightly more complicated story - South Africa has a current account deficit that’s not that far off the U.S. current account deficit in percentage of GDP terms, so the rand is vulnerable to shocks - but the one thing that we do have in our favour is that interest rates are rising in South Africa. Interest rates are on hold in the U.S., and probably the next move there is down. We have a commodity-based economy that’s in our favour, and we are in slightly better shape than the U.S. as far as the deficits are concerned - but not by that much. That’s why I say it’s a slightly more complicated story. However, on the horizon we have the private equity players - those rumours don’t go away, and they continue to exacerbate. Foreign inflows are funding the current account deficit, so certainly if the dollar continues to weaken we would see a renewed strengthening of the rand through seven, and we are actually targeting 6.92 or 6.95 against the dollar perhaps before the end of the year.
LINDSAY WILLIAMS: That’s not too far away from here. Over Thanksgiving the U.S. dollar received the same treatment as the turkey - do you think the dollar is going receive the same treatment again over this thin trading period in Europe?
DAVID GRACEY: It’s an extremely illiquid period - on Friday night the dollar was trading against the euro at 1.3350 and when we walked in this morning it was at 1.3150. Anything is likely, and the volatility is going to remain - certainly we see the dollar against the euro at 1.35 within the next month or so.
