Calm amid the global storm

What is your view of the medium-term outlook for the US dollar? Is it in chronic decline, and is its reserve currency status therefore in doubt?

The medium-term outlook is one of a slow grind lower for the greenback. We don't think the dollar is in chronic decline, largely because there is no viable alternative as a global reserve currency until Europe works out its problems with sovereign debt in its peripheral nations.

However, the US has its own debt crisis, and some of the fiscal positions of the individual states are precarious at best. This is particularly true for Illinois and California. If the focus shifts from Europe's debt problems to those in the US, then we could see the dollar sell off more sharply this year, although that isn't our central scenario.

Similarly, how do you assess the extended future for the euro, considering the systemic stresses that have been revealed by the financial crisis and recessionary forces?

The biggest problem facing the euro is the sovereign debt crisis. So far that has been contained, but if we were to see any escalation in events — a bailout for Spain for example — then things could get very nasty for the single currency. However, the euro hasn't come near to collapse even though Ireland and Greece have required bailouts.

The relative stability of the euro is partly due to the strength of the German economy. Germany makes up over half of Eurozone GDP, whereas Greece and Ireland's contribution is very small. A strong Germany equates to a strong euro.

We think that EU officials will find a solution to the crisis, and will protect the euro from collapse. If Europe can solve its debt problems, then the outlook for the euro is bright, as it would give the European Central Bank the flexibility to hike interest rates if inflation becomes a problem.

Considering the rapidly growing force of Asia economically, what are the implications for the Japanese yen and Chinese renminbi in the revised world order, in terms of relative status and performance?

It's one of a rising and a fading star. Japan's star is fading. Its public debt is enormous, more than 200 per cent of GDP. When you have a debt that large, interest rates need to be kept low — this will hurt the yen.

Even though the government in Japan is trying to heal this fiscal mess, the rising age of the population combined with sluggish growth and deflationary threats suggests it will be extremely hard to do. If the spotlight turns to Japan's fiscal problems, then the yen will fall out of favour and could be swiftly dropped as a safe haven currency.

The renminbi would be a serious contender for reserve currency, but until the currency is allowed to float freely (a scenario we think is probably years into the future), this will not happen. The authorities in Beijing are staying with their policy of slow, steady appreciation of the renminbi, and we don't think this will change anytime soon.

Do you fear significant fallout in terms of world demand from the so-called currency wars arising across the globe, including emerging markets, as countries seek to escape the downturn?

I think the term ‘currency war' is overused and doesn't adequately explain the current situation. Fast-growing emerging markets should be hiking interest rates, while the sluggish West should have loose monetary policy to boost demand. That is simple economics.

This is part of the global economic rebalancing that was talked about during the financial crisis. If it doesn't happen, then unsustainable growth patterns will persist. China needs to hike rates and boost domestic demand. That would change their economic dynamic, but it would also dampen inflation, which is too high in the emerging market powerhouse.

In contrast Brazil (whose finance minister coined the term currency war) could dampen inflation by cutting public sector spending, which would reduce inflationary pressure, limit the need for further rate hikes and take the pressure off the Brazilian real to appreciate.

We are at a difficult juncture for the global economy, but in this ‘war' it's difficult to tell the good guys from the bad guys.

What do you make of the rise and continuing strength of gold? Is it a sustainable trend in the midst of the combined concerns and uncertainties of current times?

Gold had an exceptional run last year, but it hasn't been able to sustain this good performance in 2011. As the global economic recovery gains momentum, the outlook for US growth improves — thus reducing the need for further quantitative easing from the Federal Reserve — and European debt problems look like they are contained, there is less reason for investors to buy gold, which essentially doesn't yield anything.

Now that US Treasury yields have started to rise they become a more attractive option rather than gold. In fact, the inverse relationship between gold and US ten-year Treasury yields is well known. Right now $1,420 (Dh5,216) looks like the high in the gold price. A fall below $1,330 may herald a further leg lower to the $1,290 level.

Oil is approaching the $100 level again. What is your view of the medium-term trend, given the apparent economic buoyancy of the East and relative stagnation of the West? How do you see the key drivers of the outlook?

We have revised our first-quarter 2011 crude oil outlook higher in expectation of a spillover effect from second-half 2010 global demand strength alongside tightening supply to keep oil prices supported at an average price around $88 per barrel.

We have also expanded our estimated trading range in the current quarter to $80-$100, and maintain an average price below the midpoint of the range in acknowledgement of heightened possibilities for volatility-induced price shocks arising from geopolitical (Korea tensions) and economic (eurozone periphery) risks, China tightening, and supply/demand data surprises. Supply and demand dynamics will also support oil this year.

We believe that rising demand, especially from the emerging world, will boost oil prices, which will outpace the contraction in demand for oil from the developed world.

Depending on your view of the US dollar and the template and experiences of the Eurozone, what do you feel theoretically about the GCC considering and preparing for monetary union, with the possibility of a basket benchmark? Do existing Asian pegs give any further helpful clues?

Perhaps after the sovereign debt problems in the Eurozone the GCC states will reconsider their plans for a monetary union, as this experience has highlighted the flaws in a purely monetary system. A revised plan for a GCC-zone and single currency may contain some elements of fiscal union — for example transfers of funds from rich states to poorer states in financial difficulty.

The authorities may also want to consider coming up with a default plan before they actually form the union. Right now we are witnessing a chaotic response from EU officials precisely because they hadn't pre-planned for a sovereign debt crisis. So Europe's experience is giving GCC leaders food for thought about how to form a currency union as efficiently as possible.

If the euro survives its current trials, as we believe it will, then there is no reason for a basket of dollars and the euro not to act as a benchmark for a GCC currency. This would be the logical thing to do, especially if you believe that one day we might be purchasing oil in euros or even renminbi (this is in the very far off future, in our view).

Kuwait's move to a basket of benchmark currencies for the dinar shows that it can be done, although it hasn't had a huge impact on the domestic economy. It dropped the dollar peg to try and control inflation back in 2008 when commodity prices reached record levels, but over the past six months inflation across all Gulf nations has picked up including in Kuwait (where inflation reached a 22-month high in November).

So a new benchmark might not be the deflationary force the GCC authorities believe it to be.