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Global Asset Allocation Whither the U.S. Dollar Case Solution

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732 1652 Words (5 Pages) Francis Warnock, Marc Chandler Darden School of Business : UV2553
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One of the foremost reasons why dollar could lose its value as an international medium of exchange was the failure of the United State’s geopolitical policies. However, the recent history testified to the fact that no other currency, not even euro, is strong enough to replace dollar. Williams compared the worst case geopolitical scenarios and their impacts on the dollar’s dominance with the downfall of the pound as an aftermath of Suez Canal crisis. In that case, Britain became alone in its foreign policy objectives and resultantly, pound lost its worth. However, even though US took some of very unpopular decisions in the recent past, its currency was strong enough to sustain the impact of these decisions.

Following questions are answered in this case study solution:

  1. Critique the author’s perspective on the U.S. dollar. Describe three of the most powerful arguments towards a stronger/weaker dollar. Do you agree with the author’s prospects for a stronger U.S. dollar?

  2. Currencies trade in pairs. Dollar/Euro. Dollar/Yen. Dollar/Renminbi. Choose a pair and comment on which currency will likely be the stronger currency one year from now using some of the indicators described in the book as well as additional articles on the subject.

  3. Should Rashonda Williams increase the allocation to foreign securities? Tie your decision back into your prediction for the dollar over the next 5-10 years. 

Global Asset Allocation Whither the U S Dollar Case Analysis

The most logical reason for the dollar’s dominance was that no other currency was stable enough to replace dollar and hence, it can be reasonably assumed that dollar will not lose its value suddenly, at least not in next few years. European central bank was struggling to formulate a uniform monitory policy until recently, hence, it’s quite difficult for Euro to replace dollar in the near future. The inevitability of dollar to remain as the dominant currency could be traced from the economic policies of countries all over the world during 2007-2008, when the inflation was the most severe economic problem. Not even China chose to give up its dollar investments because there was no other suitable alternative. Therefore, these events could be cited as reasons why dollar could withstand pressure in the near future, and hence remain stronger. Currently, biggest threat to the supremacy of dollar is Euro, but if we put the economic condition of European countries, it can be safely assumed that euro has still as long way to go before it can replace dollar. Most of the European countries are entangled in debt crisis arising from low tax collections and high spending.

Since Euro zone being involved in debt crisis, another potential threat to the supremacy of dollar in international trade could be Yuan, the currency of the second biggest economy of the world, China. Although China had taken some steps for the promotion of Yuan as an international currency but it was still largely controlled by Chinese government and conversion to Yuan for international traders is still very difficult.  Although some of the notable international organizations started to issue Yuan dominated bonds recently, most of the Yuan dominance remained restricted to Hong Kong, a region controlled by China. Despite all of these efforts on part of the Chinese government, Yuan still remained around 0.3% of turnover in the foreign exchange market. In the coming years, Chinese government is expected to allow foreign companies to list their shares on the Shanghai Stock Exchange. However, Chinese efforts for the dominance of Yuan are still in early stages and it can be safely assumed that Yuan is still far away from competing with dollar directly as an international medium of exchange.

Another question that Williams had in mind was, will the G7 countries support dollar if it falls even further? Although dollar regained much of its strength during the global finance crisis, it again started to enervate slowly after the crisis ended. Hence, global financial crisis merely served to support dollar temporarily and dollar’s future became as much uncertain as it was before the financial crisis. In these circumstances, Europe cannot remain silent because 40% GDP of the Europe comprises of exports, which suffers directly from the weakness of dollar. Therefore, in case the dollar’s weakness continues for a substantial period, G7 is more likely to come forward rather than remain silent. These are all the worst case scenarios that Williams is considering, otherwise, at least for next 2-3 years, dollar is expected to remain stable and there is no significant threat to its supremacy because euro and Yuan are strong enough at this stage to replace dollar.

The doubts on the future of dollar as world’s reserve currency is now questioned more than ever, the potential threats to its strength are still not strong enough to uproot its power. Therefore, Williams is right in her prospect to support US dollar and invest in favor of dollar, but only for next 2-3 years.

Currencies trade in pairs. Dollar/Euro. Dollar/Yen. Dollar/Renminbi. Choose a pair and comment on which currency will likely be the stronger currency one year from now using some of the indicators described in the book as well as additional articles on the subject

The currency that will be examined in relation to dollar in this question will be Euro. The exchange rate of a currency depends on the debt level of that region, the strength of the economy and the interest rate in that region. Euro/dollar exchange rate reached its peak value in July 2008 when it rose to 1.599 USD. This exchange rate then followed a downward path and became as low as 1.1942 USD on 8th of June, 2010 (BBC, 2011). Therefore, the recent trend of euro compared to USD has been mixed, reaching peaks at one time and then again following a downward trend. Although the Euro zone debt crisis is quite significant and it is natural to predict decrease in the value of Euro in next 12 months, US economy is also suffering from almost the same level of debt crisis (Schmidt, 2009). Therefore, any prediction of euro/dollar exchange rate should put the economic status of both the US and Europe into perspective. The Euro’s government debt to GDP ratio of 86% in 2010 was almost the same as of United States at that time. Therefore, it is not advisable to predict a decline in the value of euro compared to USD solely on the basis of euro debt crisis. Since the economy of US is suffering more than Europe, it can be safely predicted that the although the euro/dollar exchange rate will deteriorate, the decline in the exchange rate will be nominal because United State’s economy is subject to the same problems that may hamper the value of euro (Exchange Rate Predictions, 2011). So, Euro is expected to remain stronger than USD 12 months from now as it is now with only marginal changes in the exchange rate.

Should Rashonda Williams increase the allocation to foreign securities? Tie your decision back into your prediction for the dollar over the next 5-10 years.

The decision about increasing the allocation to foreign securities depends on the length of investment that the management has in mind. Based on the assessment of short term prospects, it can be concluded that Williams should favor dollar because dollar has still no potential alternative, at least for the next 2-3 years. However, the future of dollar as world reserve currency has become more and questionable as we move ahead. In the long run, there are many serious threats to the supremacy of dollar as Euro gain more strength with time, the effects of which will become tangible in next 5-10 years. As stated by Frankel in his blog “that tipping point could come within the 10-year horizon: the euro could overtake the dollar (as world’s reserve currency) even as early as 2015”.

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