Challengers for global reserve currency status are appearing on the horizon for the US dollar, which has dominated foreign exchange and trade reserves for the last 70 years.
Stuart Simmons, senior portfolio manager at QIC, said world markets were at an “inflection point”, where reserve currency and reserve assets were shifting, with Europe a top challenger.
“We are moving to a more multipolar environment and this could add to some of those tensions that we’ve already got around trade and other geopolitical issues,” Simmons said. “Since (the GFC), we’ve seen green shoots in Europe. You’ve got an environment where your credibility improved, particularly after the French election, and an environment where the European Central Bank has unwound its accommodative and extraordinary measures [albeit at a glacial pace] and the outlook for the euro as a challenger has improved.”
He still called de-dollarisation a long-term play, even though China, Russia, and India have agreed to accept each other’s currencies for bilateral trade and Europe has held the euro together.
“China is trying to make themselves more of a challenger as a reserve currency, they acknowledge the benefits of that,” Simmons said. “But if you look at the attributes of a reserve currency, China has the economic size and geopolitical power but fails on (other) measures.”
Simmons spoke at the 2018 Fiduciary Investors Symposium in the Blue Mountains in May, alongside AMP Capital head of dynamic markets and portfolio manager Nader Naeimi.
Naeimi said China was “flexing its muscles” to take on world reserve currency status.
“China is working to de-dollarise lending across Asia,” he said. “They’re trying to de-dollarise Asia but want a closed capital account and the only way to do this is to have a lot of gold.”
The US currency decoupled from gold during the Nixon presidency and the rise of the dollar since then had been “a bit like a Ponzi scheme”, he said, with the US in the unsustainable position of being able to issue and pay debt in its own currency. China’s latest move has created a “fascinating macro backdrop” of tension between the two nations, amplified by the relationship between gold and long-term US bond yield.
“Every time gold goes up, China is winning and every time the US long-term bonds are going up, the US is winning,” Naeimi said.
Simmons argued that superannuation funds should, therefore, interpret currencies in three ways to help pursue their investment objectives.
First, he explained, they should use a coherent process to define their strategic hedge ratio, second, they should look at triggers, identifying a strategy for moving that hedge ratio throughout the cycle.
“The third part, and probably the most neglected, is what you do with that foreign currency composition, whether you leave them at your equity weights or try to do something smarter to try to help achieve those objectives, be it over developed or emerging markets,” Simmons said. “Particularly as we move to a more low-return environment, you’ve got to have a holistic approach to the currency framework, which can help in pursuing those objectives.”