Monday, March 30, 2009

What Happens if the Dollar is Dethroned?

The Wall Street Journal-There could be far-reaching implications for commodities should the U.S. dollar lose its status as the world's reserve currency.

While such a move could mean more demand for commodities as a hard asset, or "store of value," if there were a general distrust of all currencies, there are differing views on whether it would mean less currency-related fluctuations in pricing of commodities and just what the impact might be on producers around the globe.

It also would remain to be seen whether the world would go to the International Monetary Fund's Special Drawing Rights program -- a reserve asset based on the value of a basket of four currencies -- and whether commodity exchanges would automatically follow suit.

Last Wednesday, Treasury Secretary Timothy Geithner prompted a drop in the dollar when he suggested the U.S. would be "open" to an expansion of the IMF's SDR program, a move China had suggested two days prior. The market initially treated this as consideration for a new global reserve currency, but the greenback quickly recovered as the foreign-exchange market soon dismissed the remark as a misstep. Mr. Geithner himself maintained the dollar would remain the world's dominant currency.

Still, it raises the question of what might happen to commodities if the dollar was no longer king, even though some commodity analysts, such as Logic Advisors principal Bill O'Neill, describe the question as academic more than anything.

"This is an extremely hypothetical situation," said Sterling Smith, vice president with FuturesOne. "I'm not entirely sure it would work all that well."

Commodities such as oil are traded in dollars not only in the U.S. but also on some of the other major exchanges in the world, such as London. This means potential for changes in the supply-demand dynamics whenever the dollar makes a big move. For instance, a weak dollar tends to support commodities by making them cheaper in other currencies and theoretically improving demand, and vice versa.

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