Backing the dollar

June 3, 2009 — Mitul Kotecha

There has been no let up in the bullish tone to markets over recent weeks. Optimism is dominating. Meanwhile, commodity prices continue to remain firmly supported, with the CRB commodities index up around 30% from its early March low. Bank funding has improved sharply, with indicators such as the Libor-OIS spread moving to its lowest spread since the beginning of February 2008 whilst the Ted spread is now close to where it was all the way back in August 2007.

Conversely, there is not much sign of a let up in pressure on the dollar despite assurances from US Treasury Secretary Geithner during his visit to China. Much of the move in the dollar continues to be driven by improvements in risk appetite but worries about the sustainability of foreign buying of US assets have increased too.

Russia’s proposal to create a new supranational currency has dealt the dollar another blow but it was notable that India, China and South Korea were reported to express confidence in the dollar, stating that there is no alternative to the dollar as a reserve currency. Such comments highlight that despite political motivation to move away from the dollar it is no easy process.

The comments from India, China and South Korea, three of the world’s biggest reserve holders reflect the growing concerns from official accounts about 1) dollar weakness getting out of control and 2) US bond yields pushing higher. Even though foreign central banks will continue to diversify the last thing they want to do is to destroy the value of their massive amounts of US asset holdings so don’t expect a quick move out of dollars from central banks despite the rhetoric from Russia and others.

Russia has said that a debate about the dominance of the USD will take place when BRIC (Brazil, Russia, India and China) countries meet on June 16. Although the rhetoric from Russia may add to dollar worries the reality is that it is highly unlikely that any form of concrete plan will be easily developed to shift away from the dollar. Political motivations aside, even Russian President Medvedev admits it’s an “idea for the future”.

Posted in Bond markets, central banks, China, Commodities, Currencies, Financial crisis, India, US. Tags: , , , , , , , , , , , , , , , . 1 Comment »

Are foreign investors really turning away from US debt?

May 29, 2009 — Mitul Kotecha

The press has been full of stories about the dangers to US credit ratings and growing concerns by foreign official investors about the value of their holdings of US Treasury bonds.   A combination of concerns about the rising US fiscal deficit, Fed quantitative easing and potential monetization of US debt, have accumulated to fuel such fears. Given the symbiotic relationship between China and the US it is perhaps unsurprising that China has been one of the most vocal critics. I have highlighted this in past posts, especially related to the risks to the US dollar. Please refer to US dolllar beaten by the bears and US dolllar under pressure. However, my concerns that foreign investors have been shunning US Treasuries recently may have proved somewhat premature.

Should China or other large reserves holders pull out of US asset markets, it would imply a sharp rise in US bond yields and a much weaker dollar.  However, it is not easy for China or any other central bank to act on such concerns.  China is faced with a “dollar trap” in that any decline in their buying of US Treasuries would undoubtedly reduce the value of their existing Treasury holdings as well as drive up the value of the Chinese yuan as the dollar weakens.  Such a self defeating policy would clearly be unwelcome. 

One solution that China has proposed to reduce the global reliance on the dollar and in turn US assets was to make greater use of Special Drawing Rights (SDRs) which I discussed in a previous post, but in reality this would be fraught with technical difficulties and would in any case take years to achieve.  Nor will it be quick or easy for China to persuade other countries to make more use of the yuan in the place of the dollar.  The first problem in doing so is that fact that the yuan is not a convertible currency and therefore foreign holders would have difficulties in doing much with the currency.  

Foreign official concerns are understandable but whether this translates into a major drop in buying of US Treasuries is another issue all together.  Foreign countries have been gradually reducing their share of dollars in foreign exchange reserves over a period of years.  This is supported by IMF data which shows that dollar holdings in the composition of foreign exchange reserves have fallen from over 70% in 1999 to around 64% at the end of last year.

In contrast the share of euro in global foreign exchange reserves has increased to 27% from 18% over the same period.  This process of diversification likely reflects the growing importance of other major currencies in terms of trade and capital flows, especially the euro, but the pace of diversification can hardly be labeled as rapid. 

Importantly, there is no sign that there has been an acceleration of diversification over recent weeks or months.  Fed custody holdings for foreign official investors have held up well.  In fact, these holdings have actually increased over recent weeks.  Moreover, the share of indirect bids (foreign official participation) in US Treasury auctions have been strong over recent weeks.  Taken together it provides yet more evidence that foreign official investors haven’t shifted away from US bonds despite all the rhetoric. 

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, Europe, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , . 5 Comments »

End of the road for the dollar?

March 25, 2009 — Mitul Kotecha

The comments by China’s central bank governor  about the US dollar have provoked much speculation ahead of next week’s G20 meeting in London about the potential for the world’s biggest reserves holder (around $2 trillion) to shift away from dollars. The idea of China’s central bank governor is to use SDRs as an alternative to the US dollar. China’s concerns focus on the risks of a big increase in inflation in the wake of the Fed’s plan to move to full blown quantitative easing by buying US Treasuries as well as the massive blowout in the US budget deficit. This would hit the value of China’s massive (over $700 billion) holdings of US Treasuries.

Don’t get too excited though. The likelihood of any change in the use of the dollar as a reserve currency is extremely limited. Using the SDR would itself involve many technical issues in terms of how much to issue and whether companies and investors would accept the use of SDRs rather than dollars. Such a move would take years. The reality is that the risks to the dollar have clearly risen and the crisis and money printing by the Fed has fuelled significant risks over the medium term, to foreign holders of US debt such as China. Nonetheless, there is no other currency that is in a position to displace it at the moment and possibly for several years. Eventually the use of the euro and even the Chinese yuan may reach a point when they share the status of reserve currency with the dollar, but this is not going to happen anytime soon. In other words there is no need to go get rid of your Greenbacks just yet.

Posted in Asia, Currencies. Tags: , , , , . 2 Comments »
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