The weakness and volatility of the dollar in the past several years has led to calls in the diamond and other industries for it to be replaced by another currency or an asset representing a basket of currencies.
For as long as most people can remember, the world’s main currency has been the U.S. dollar, Antwerp Facets writes. Indeed, it goes without saying that the prices of all commodities are in dollars, and that the greenback is the world’s reserve currency. But is the dollar’s days numbered, and might a different currency or an international reserve asset be created to take its place? And what has been the impact on the diamond trade from the steep decline in the value of the dollar against currencies across the world?
The debate over the future of the dollar has been going on for many years, but it received fresh impetus following the global financial crisis of 2008 and the worldwide slowdown in 2009. The U.S. economy is still struggling to create a full-blown recovery, despite the pumping of hundreds of billions of dollars into its economy by the Federal Reserve Bank, which has, in turn, stoked fears of inflation.
The Fed has also kept interest rates at record lows, causing the value of the dollar to plunge across the globe as investors sell dollars and buy currencies offering higher interest rates. As confidence in the future of the United States as the world’s leading economic powerhouse has fallen, so has belief in the dollar.
As with most internationally traded goods, the diamond industry is also reliant on the dollar for pricing of rough and polished diamonds, and has been hit to varying extents by the falling value of the U.S. currency. Although, on the face of it, the diamond industry should not suffer from the dollar’s decline since goods are bought and sold in the American currency, the reality has been different. Diamond companies need to pay their regular expenditures in their domestic currency which, in the case of Belgium, in addition to India and Israel, have become more expensive against the dollar in which they earn their income.
Belgian companies, for example, saw the euro launched on January 1, 1999, at parity to the dollar and for a couple of years until mid-2002 the dollar bought from 1.00 to 1.20 euros. From May 2002, however, the dollar has been on a long slide and today buys just 0.73 of a euro. In other words, a diamond sold for $1,000 in 2002 raised around 1,200 euros, but today brings in just 730 euros. Taken together with rising wages and standards of living, the falling dollar means financial problems for Belgian diamantaires, as it does for their counterparts in other diamond centres.
As for other currencies, the dollar has fallen around 10 percent against the yen and by a third against the Swiss franc in the past decade. The trade-weighted U.S. dollar index, which gauges the value of the dollar compared to other world currencies, has lost 11 percent in the past 10 years. The dollar has also fallen by close to 40 percent against its northern neighbour – the Canadian dollar.
“Since the buying and selling of diamonds takes place according to the U.S. dollar, theoretically there should be no problem,” said one Belgian diamond polisher. “However, what happens when you buy rough diamonds and then sell them several months later when the dollar has declined? There are ways of guarding against that, but buying that protection also costs money since it is a type of insurance.
“There is also the problem of having to pay salaries and the other overheads in euros. Of course, a lot of trading takes place between Antwerp companies so the payment is in euros, but ultimately everything is connected to the dollar. We are buying rough according to the dollar, and have to hope that the dollar rate stays stable when the time comes to sell the polished goods,” he added.
The falling value of the dollar also causes financial stress upstream, with mining companies operating in countries such as South Africa and Canada, which have seen their currencies perform strongly against the dollar, receiving less money for their diamonds while having to pay workers, mining and other costs in expensive rands and Canadian dollars.
The impact of the falling dollar has been uneven across the globe, however, explained P.N. Prasad, managing director of the Antwerp branch of the State Bank of India. “The local operating costs of Belgian firms are only equivalent to 2-3 percent of their turnover because Antwerp is largely a trading centre so companies have comparatively small operations here. These are to do with office costs, salaries and so on, so the impact is relatively small,” Prasad said. “By comparison, India is a different story because it is a manufacturing centre with plants that employ many workers. Its local operating costs are much higher, and typically account for 15-20 percent of turnover.
“One also finds in Antwerp that around 20 percent of trading is done in euros and the rest in dollars, so that also helps mitigate the overall impact of the weaker dollar. In addition, there are financial instruments available, called ‘foreign cover’ that enable firms to plan ahead against the impact of currency fluctuations,” Prasad added.
As to the issue of the dollar in the wider global trading arena, economists have long debated whether a single reserve currency can dominate the global economy indefinitely. Is it possible the world will soon begin to move away from a financial system dominated uniquely by the U.S. dollar due to its weakness? Such a large-scale movement has happened before.
Just 100 years ago, several currencies shared the status of being primary reserve currencies. Although the British pound was the largest single currency in the world, both the French franc and the German mark played important roles in global markets until the First World War. Following the war, the mark was replaced by the dollar, and since the end of the Second World War, the dollar has dominated official reserves and international trading.
Former leading members of the diamond industry have also raised the issue of trading in a different currency to the dollar due to its depreciation over the past several years. These include former Alrosa President Sergei Vybornov who suggested that the euro or Swiss franc should replace the dollar as the diamond industry's trading currency. "The average life of a mine is 30 years so you have to plan this horizon but you can't with all this uncertainty going on. We just don't know what will happen with the dollar tomorrow."
Former De Beers CEO Gareth Penny also suggested the industry should consider whether a change of currency was justified. "We commenced trade with U.S. dollars 40 years ago,” he said at an international rough diamond conference in Israel in 2008. “Is it time for a change in currency?” Neither Vybornov nor Penny is involved in the diamond industry any longer, and no other members have since brought up the issue of using a different currency.
The top reserve currency is generally selected by the banking and business sectors for the strength and stability of the economy in which it is used. As a result, as an economy loses its dominance, its currency can be expected to become less stable and businesses abandon it for a currency issued by a larger or more stable economy. On the face of it, this is what is happening to the U.S. dollar. However, the process of moving to a different currency is a long-term process, and the alternatives also face problems of their own.
The most obvious alternative currency is the euro, particularly given the fact that Europe is a huge trading area. However, the euro has only been adopted by 17 states out of the 27 member states of the wider European Union, which is hardly a vote of confidence, says Prasad. More importantly, the euro zone has faced severe financial turbulence in the past year due to the economic turmoil in Greece, Spain, Portugal, Italy and Ireland.
“It is clear that governments lose a lot of control when they adopt the euro, and that it is extremely difficult to control a trading bloc featuring so many different countries,” Prasad said. “The euro zone is a monetary union, and despite its moves to promote trade between members, it is far from having the advantages of the United States – a united country all speaking the same language, using the same currency and with complete freedom of movement of goods and services,” he added.
However, some important financial figures have forecast that the era of the dollar’s supremacy has started its countdown. Former U.S. Federal Reserve Bank Chairman Alan Greenspan said in 2007 that the euro could replace the U.S. dollar as the world's primary reserve currency. It was “absolutely conceivable that the euro will replace the dollar as reserve currency, or will be traded as an equally important reserve currency.” Meanwhile, some economists have said that the euro could replace the dollar as the major reserve currency by 2020 if two conditions are met. These are that the remaining EU members, including Britain, adopt the euro by 2020, or that the dollar continues to depreciate.
Given that even an EU-friendly Labour government that was in power for 13 years in Britain was unable to win the case for adoption of the euro, however, that route seems unlikely. And the turmoil in the euro zone in the past year and the need for richer member states to bail-out their troubled neighbours is unlikely to persuade the UK and other states to forgo independence in economic policy. Furthermore, European Central Bank president Jean-Claude Trichet said in late 2009 that the euro was not designed to be a global reserve currency.
Meanwhile, countries such as Russia and members of the Gulf Cooperation Council have issued calls for the dollar to be replaced. However, that is likely due to the fact that they are major oil producers and are looking for a stable currency in which to price their exports. Indeed in 2009, Russian President Medvedev proposed a new “world currency” at the G8 meeting in London as an alternative reserve currency to replace the dollar, however he did not make solid recommendations. China, for its part, has proposed using the so-called Special Drawing Rights (SDRS) used by the International Monetary Fund for international payments and calculated daily from a basket of currencies including the U.S. dollar, the euro, the yen and the British pound.
Even a hard-hitting report by the United Nations that called for abandoning the U.S. dollar as the main global reserve currency because it had failed to safeguard value is unlikely to have much of an impact on the dollar’s position.
"The dollar has proved not to be a stable store of value, which is a requisite for a stable reserve currency," according to the U.N. World Economic and Social Survey 2010. Developing countries have been hit by the U.S. dollar's loss of value in recent years. "Motivated in part by needs for self-insurance against volatility in commodity markets and capital flows, many developing countries accumulated vast amounts of such (U.S. dollar) reserves during the 2000s," the report said.
But politicians and officials have pointed out that only the market can determine in which currencies companies would trade. The report recommended replacing the dollar with the IMF’s SDRs. "A new global reserve system could be created, one that no longer relies on the United States dollar as the single major reserve currency," the U.N. report said. A new reserve system "must not be based on a single currency or even multiple national currencies but instead, should permit the emission of international liquidity — such as SDRs — to create a more stable global financial system."
There is a growing belief that global trade will move away from the dollar as a reserve currency, with fewer than 20 percent of executives surveyed by international business consulting firm McKinsey expecting the dollar to be the main global reserve currency by 2025. However, since there is no clear direction regarding which currency will be adopted, it appears clear that for the foreseeable future the dollar will remain the world’s reserve currency because it is known and trusted by businesses across the world.
