So is the status of the dollar as the world’s reserve currency in jeopardy?  A valid question as the US runs up a $1.7 trillion dollar deficit, 10% employment, and contracting GDP figures.  Despite these grueling realities, in our opinion here at Notes , the short to medium term outlook on the dollar remains strong.  In the long term, however, we expect a slow, painful dollar demise.  Here’s why:
There has been a lot of rumblings amongst the BRIC nations about displacing the dollar with a new international currency with special drawing rights (SDR).  China and Russia have been most vocal about their SDR support, and yesterday India’s Foreign Secretary Shivshankar Menon said the idea to replace the dollar was “one of the ideas which is on the table” at the upcoming G5 meeting.  Even France has thrown its ever diminishing, political capital behind such an idea.

Despite pathetic fundamentals in the US economy, America still stands as the sole economic superpower.  If you think our situation is bad, look at the UK, Europe, or Japan and their respective currencies.  It’s a bloodbath over there.

But then there is China.  As China is very well positioned to become the world’s largest exporter over the next years, the renminbi could challenge the dollar’s reserve currency status.  But one caveat remains, in that in order to become the world’s reserve currency, the Chinese government would have to float the renminbi and remove capital controls; not something we expect from the central planners in Beijing anytime soon.

In today’s Financial Times, David Woo, head of FX strategy at Barclays, had this to say about the state of the dollar:

Notwithstanding the problems with the current global reserve system, there are at present no obvious alternatives to the dollar. That said, US fiscal profligacy will push the dollar risk premium higher over time. In other words, the US’s ability to obtain cheap external funding for financing its twin deficits is likely to be curtailed. In the near term, the global economy remains too fragile to absorb the shock of a large and disorderly decline of the dollar. In that respect, the chances for coordinated intervention among developed economies to support the dollar are higher now than any time in the past 10 years.

So where does this leave you, dear reader?  How can you play a short to medium term, strong dollar?  Well, for one, hold dollars now. Or you could buy PowerShares DB US Dollar Index Bullish (NYSE: UUP) and hold it for the short to medium term.  But don’t forget about it.  The long term dollar story isn’t pretty.