RISK MANAGEMENT | 14 OCTOBER 2022 Does the Dollar Still Dominate? Absa | Corporate and Investment Banking > Insights and Events > Does the Dollar Still Dominate? Mike Keenan Head of Fixed Income and Currency Research SHARE The US dollar gets most of the attention when it comes to foreign exchange. Why is that? If you’re tracking currency markets, you’re inevitably tracking the US dollar. The greenback is so powerful that its relative strength or weakness in foreign exchange (forex, or FX) markets can have far-reaching impacts, sometimes even influencing other countries’ monetary policies. But despite – or because of – the dollar’s dominance, other currencies also demand attention. “Countries often fall victim to dollar dynamics,” says Mike Keenan, Head of Fixed Income and Currency Research at Absa CIB, recalling former US Treasury Secretary John Connally’s famous line at the 1971 G-10 meeting in Rome: “Our dollar, your problem.” “When the dollar strengthens – as it has been doing in late 2022 – its dominance as an international unit of account and as a reserve currency sometimes means that other countries’ central banks have to do things that they don’t necessarily want to do,” Keenan explains. “They have to defend their own currency and keep a lid on inflation. If we didn’t have that dollar dominance, those countries might not feel coerced into implementing those monetary policy measures.” Currencies beyond the majors For South Africans – and for currency analysts like Keenan – there’s a raft of “secondary” currencies, outside of the majors, that will be of interest. “A lot of European countries have by now been incorporated into the euro, but you still have the likes of the Polish złoty and the Turkish lira, which are still emerging market currencies,” he says. “You will see investors comparing the various values of those currencies across the board, but this is more related to financial flows than to transactions.” A lot of that comparison is to show the relative value between assets among emerging markets: South Africa’s rand versus, for example, the Brazilian real, Mexican peso or Indian rupee. However, when it comes to trade flows the dollar is still king. “It’s really just the majors,” says Keenan. “It’s the dollar, sterling, euro, yen … and now, more and more, China. They’re pushing hard to become part of the IMF’s SDR [Special Drawing Rights] basket and the like. They want to be seen as one of the major currencies, because the dollar is such a dominant currency – partly because, from a monetary policy point of view, they feel that they’ve often fallen victim to the dollar dynamic.” Why the dollar is still king When it comes to financial flows, the dollar dominates again. “If you look at the global currency turnover in general, the vast majority of trade is done in dollars,” says Keenan. “The market for dollar/rand is much more liquid than the market for euro/rand, so if South Africa needs to pay for something in Germany, for example, you’ll draw the dollars and exchange them for euros thereafter. This can be more costly because you’re crossing two spreads.” But the dollar is not the only show in town – at least, not if China can help it. “We’re seeing a noticeable shift around the Chinese yuan or renminbi,” says Keenan. “There’s an increased demand for importers to pay their Chinese suppliers in that currency. When it comes to any cross-border flows – and particularly when it comes to the importation of goods and services – whoever the producer is would typically like to have the account paid in the currency of the residents. There are many exceptions to that rule, however.” South Africa’s Southern African Development Community neighbours Namibia and Botswana have both pegged their currencies to the rand, so accounts would typically be paid in rands. But as one moves further north, beyond the common currency area, the US dollar becomes the currency of choice. South Africa’s main overseas trading partners include China, the US, Europe, the UK and Japan – and South African importers typically pay exporters in those countries in their respective currencies. “For a long time China was quite happy to take US dollars,” Keenan concludes, “but that has shifted and importers are starting to pay them more and more in their own currency.” Mike KeenanHead of Fixed Income and Currency Research https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles RISK MANAGEMENT The Development Organisations The Development Organisations (DO) sector is a specialised team dedicated to serving the banking needs and managing relationships with a diverse range of renowned Development Aid Organisations (DAO) and their partners across Africa, America, Europe and the UK. Leveraging Absa's extensive banking offering and a deep understanding of these International Organisations across different regions, the team offers unique insights into the exclusive requirements of these organizations on a Local, Regional and Global level. Read more Podcasts How The AfCFTA will enable digital trade In this podcast, we explore the opportunities of the African Continental Free Trade Area’s protocol on digital trade. What will it mean for cross-border trade, and what do African businesses need to know? RISK MANAGEMENT Why Africa can be the beating heart of South Korea’s technology industry Tshepo Ncube, Head: International Coverage and Bhavtik Vallabhjee, Head: Power, Utilities & Infrastructure at Absa CIB reflect on their recent visit to South Korea, examining why investors in the region have their eyes set on Africa to nurture healthy investment possibilities. Read more
