Growth will come from multiple sources

USD traded mixed Monday as the G-20 meeting ends without a fresh call to replace the USD as the world's reserve currency. G-20 officials announced Friday that the G-20 will supplant the G-8 as the international economic council and include developing nations like China, Brazil and India. The G-20 proposes a comprehensive approach to rebalancing the global economy which will include assessments of fiscal and monetary policies, trade and Forex. The G-20 also pledged to increase representation of emerging market and developing countries. The G-20 communiqué made no mention of USD reserve status. World Bank President Robert Zoellick says the US should not take for granted USD status as the world's reserve currency. Zoellick said there are a number of options emerging and that the G-20 meeting presents a good start towards increased global cooperation. According to Zoellick forces are shifting and now is the time to prepare for the fact that growth will come from multiple sources. Reuters reports that Zoellick said we need a system of international political economy that reflects a new multi polarity of growth.

Fed policy out of sync with emerging economies

According to analysts at HSBC ultra accommodative Fed policy and concern about rising US budget deficits threatens the USD reserve status. HSBC says the Forex landscape is changing as sovereign debt levels rise sharply in the US and ultra-easy Fed policy and implementation of quantitative ease are out of line with the economies of Asia, the Middle East and Latin America. With US interest rates expected to remain near zero through mid-2010 the USD is emerging as the world's funding currency replacing the JPY. This has encouraged emerging market governments to seek closer currency ties with regional trading partners and to call for the replacement of the USD as the global reserve currency.

Global imbalances continue to widen

Global economic imbalances are blamed for the latest financial crisis. The widening gap between savings and investment has led to widening US deficits and Asian surpluses. The US deficit is expected to top 1.6 trln in 2009 and 9 trln over the next decade. The G-20 will need to encourage the US to cut its deficit and increase savings, and China will have to reduce reliance on exports. US officials have indicated that global growth cannot be dependent solely on the American consumer. Treasury Secretary Geithner says we are already seeing the first signs of increased savings rate in US. In March China's PM Wen expressed concern about the value 800 bln in US bonds that China holds. The founder of Tiger Management Julian Roberts warns that if China and Japan stopped buying US debt it could lead to financial Armageddon. He went onto say that that this is unlikely at this time because China and Japan do not want to undermine the value of their US holdings. The Obama administration has pledged to reduce the US budget deficit but this will be difficult if US unemployment remains high and Congress does not find a way to pay for US healthcare reform.

Fed slowly begins an exit strategy

Fed Governor Warsh said that actions to remove accommodative policy will come before they are obviously needed and will need to be faster and stronger than customary. Warsh however gave no sign as to when the Fed would begin to tighten. Last week the Fed announced that it will scale back two lending programs. The Fed will reduce the amount of money available for banks in short-term loans under TAF and will cut back the program that allows investment firms to swap risk assets for treasuries. This action comes in response to improvement in the financial market conditions with economy emerging from recession. The Fed is beginning the exit strategy from extraordinary support. However, a Fed tightening is not expected until next spring. The Fed also announced that it will extend its purchase of mortgage-backed securities and agency debt into Q1 2010.

No viable alternative yet

There is no viable alternative to USD as the reserve currency currently because there is no competition to depth of US capital markets. As the US savings rate improves and US takes action to reduce its debt burden the USD may find a temporary reprieve from G-20 pressure to replace the USD as the global reserve currency. The G-20 communiqué calls for peer country review of economic polices. The short-term direction of the USD will be significantly impacted by the Fed's exit strategy from extraordinary monetary stimulus. It may be more than coincidence that the USD has is stabilized since last week's FOMC meeting which signaled the Fed is slowly beginning an exit strategy by announcing scaling back of two emergency programs. The G-20 peer review will be monitoring future Fed and US government plans to withdraw stimulus.