Not so many years ago, economic analysts were arguing that the euro would soon replace the dollar as the preferred reserve currency for central banks in countries like China, which were accumulating substantial trade surpluses. These countries often traded in dollars. While the weakness of the dollar helped them export more, the accumulated currency reserves were depreciating at a fast rate.

How times change! In the last year the euro has lost more than 20 per cent of its value against the dollar. Analysts are now speaking about the reign of ‘King Dollar’. “King Dollar can be an enlightened ruler or a vicious tyrant, depending on where you stand!” stated one analyst. So what is causing this reversal in the market’s perception on the future of the dollar?

One obvious answer is that the US economy is performing better than that of the eurozone. Admittedly most of this good performance is based on increase in consumption spending as the feel good factor returns to the US.

In contrast, the eurozone continues to struggle with weak political governance, reluctance to undertake structural reforms and stubbornly high unemployment. All this is contributing to the EU’s sluggish economic growth.

So investors are rushing to invest in the US, where interest rates are likely to start rising again in the coming months. US assets – including stocks and bonds – are appreciating at a fast rate making US consumers feel richer, giving them a justifiable reason to spend more.

The situation in the eurozone is rather bleaker. With youth unemployment at record levels, hardly noticeable political cohesion, geo­political problems becoming more acute, and with a low appetite for structural reforms, the only weapon that is left is monetary policy. But quantitative easing and low interest rates will never be enough to stimulate growth in the real economy.

Financial assets in the eurozone will continue to appreciate, but shrewd investors will prefer to put their faith in the stronger US economy. Many ordinary people wonder how a strong US dollar is likely to affect the Maltese economy.

We need to acknowledge that the effects of a strong dollar are so complex that even the most experienced economists will probably fail to agree on what is likely to happen.

In the last year the euro has lost more than 20 per cent of its value against the dollar

But some conclusions are indisputable. A strong dollar is unlikely to convince more Americans to visit Malta because our tourists predominantly come from the eurozone.

Countries like France, Italy and Germany stand to benefit more from the strong dollar as these countries are better known in the US.

Hopefully, the strengthening of sterling against the euro, even if less impressive than that of the dollar, will convince more British visitors to choose Malta for their holidays.

One of the complexities that make it difficult to predict the possible outcome of a strong dollar on the Maltese economy is the weakening of oil prices.

It is almost axiomatic that as the dollar gets stronger, the price of oil is likely to weaken.

Of course this is an oversimplification because the dynamics that determine the price of oil are also influenced by the interplay of supply and demand.

We are completely dependent on oil and gas for our energy generation. Even with more efficient power generating facilities, we will continue to be directly affected by what happens in the oil and gas markets that use the dollar tor trading transactions.

Traditionally our energy utility as well as our national airline has used hedging to control to some extent the price volatility and other derivative financial instruments to manage currency risks. But these are very unrefined tools that still leave their users exposed to certain risks.

Manufacturing activities are becoming less important in our economy. Some of the major manufacturing businesses in Malta may be invoicing their clients in US dollars while most of their costs will be incurred in euro. The strengthening of the dollar should help these companies improve their profitability as they get more euros when they convert the dollar sale proceeds into euros. Since we mainly trade with other eurozone countries, the weakening of the euro is likely to have a neutral affect on our economy.

Our business leaders will be wise if they continue to concentrate on improving productivity through higher investment in human resources and technology to promote growth.

Our political leaders need to concentrate more on the structural reforms that are necessary to attract more foreign direct investment.

‘King Dollar’ will not do us any favours.

johncassarwhite@yahoo.com

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