When North Korea opted to launch three short-range missiles off its eastern coast in May, following a nuclear test, the value of the U.S. dollar rallied. The “safe harbor” status of the dollar was suddenly renewed, following an earlier downturn in its value that has sparked a debate as to whether it will be supplanted by the euro, yen and renminbi or some combination thereof.  

We think that it is too early to write off the dollar.  Like it or not, the dollar remains the world’s reserve currency and there is nothing out on the horizon to change that – at least through the next couple of years. Currently the dollar/euro exchange rate is at $1.39 and the yen/dollar is around 94.60. We see the year-end 2009 euro/dollar rate at $1.36 and yen/dollar at 100, which means a mild weakening in the euro and yen. Yet, looking to end-2010 we do not see much change in these exchange rates.  Why?

In his Biography of the Dollar (2007), The Wall Street Journal’s Craig Karmin, notes that the U.S. currency is undergoing an “existential crisis”. By this he means that with the introduction of the euro, the economic strengthening of the BRICs (Brazil, India, Russia and China), and the economic crisis that started in 2007, there is less certainty about the real value of the dollar. Indeed, as James Grant, the publisher of Grant’s Interest Rate Observer, once noted of the U.S. national currency with significance for the current environment: “It is a paper claim of no inherent value that is accepted on its face in every corner of the earth. There is nothing behind it but the idea of America.”   One could argue that the Financial Panic of 2007-08 and ensuing Great Recession have questioned the idea of America.