despite all the worldwide handwringing about Helicopter Ben and his printing presses, the dollar is still the daddy

TO BE NOTED: From Inca Kola News:

"With Bloomie blasting silly headlines about Chile's Peso (CLP) being "the world's best currency this week" and Colombia's "the worst", I thought it was high time to revisit the evolution of local currencies versus the dollar and get a bit of perspective. This one year chart....

.....shows the various rises and falls (or in Argentina's case rises and rises) against the dollar for the major locally floated currencies (not much point in featuring the Vzla Bolivar Fuerte here, and Paraguay's Guaraní.....well, it's never going to attract the attention of George Soros, is it?).

The main takeaway? Some currencies are strengthing back more quickly than others. But in the end, when push comes to shove and despite all the worldwide handwringing about Helicopter Ben and his printing presses, the dollar is still the daddy. Every single major trade currency in LatAm is down against the dollar YoY, even the economic miracle packaged up for saps with a bow and labelled Peru. And with base lending rates dropping fast all over the region as countries try to stimulate growth, the attraction of parking cash at higher risk is lessening, too.

Anecdotally, if you ever need a lesson in what the term "reserve currency" really means come down here with a thousand British Pounds, or Euros, of Aussies or Loonies or even an ounce of gold in your pocket and try to exchange them for the local currency of your choice and at the same time get the same fair deal you'd get for the equivalent amount of USDs. They say travel broadens the mind.................."

investors’ short-term deflationary fears are slowly giving way to long-term inflationary worries

TO BE NOTED: From Alphaville:

"Oil at six-month high Posted by Izabella Kaminska on May 29 12:27.

Crikey, that’s quite a spike in WTI oil futures on Friday:

Interestingly, this is how the dollar is trading versus the euro on Friday:

Dollar index:

No similarity there at all, huh?

Related links:
So who says there’s no oil/dollar correlation - FT Alphaville
The coming oil-equity disconnect or the end of efficient markets theory? - FT Alphaville
Oil, the great inflation hedge - FT Alphaville

This entry was posted by Izabella Kaminska on Friday, May 29th, 2009 at 12:27 and is filed under Capital markets, Commodities. Tagged with Dollar, nymex wti futures, oil."

"So who says there’s no oil/dollar correlation? Posted by Izabella Kaminska on May 19 13:57.

When oil behaves irrationally at the moment, it seems there’s usually only one explanation offered: it’s trading in an opposite direction to the dollar.

RBC Capital sums up the return of this significant correlation in the following chart:

As can be seen, it appears the correlation slipped out of place from October 2008 until February 2009 - the peak of the financial crisis - and since then has increasingly been coming back into play.

Barcap’s David Woo, meanwhile, makes a similar observation, but this time charts oil’s performance versus EUR/USD specifically:

Interestingly he concludes (our emphasis):

If the key drivers behind the spike in the EUR/USD-oil correlation in the middle of last year were aggressive interest rate cuts by the Fed and the strong consensus at the time about decoupling, what is driving up the correlation now? In our view, the context is different but the reasons are the same. In recent weeks, sentiment towards global growth has improved, and in particular, the acceleration of the Chinese economy has fuelled hopes that Asia and some parts of Latin American will recover before the US.

At the same time, investors are concerned about the lack of a credible exit strategy from QE and the potential long-term consequences of the massive buildup of US government debt and contingent liabilities. The fact that inflation breakevens on TIPS are widening and gold prices remain above $900 an ounce (Figure 4) despite the dramatic abatement in risk aversion is consistent with the hypothesis that investors’ short-term deflationary fears are slowly giving way to long-term inflationary worries. Related links:
The coming oil-equity disconnect or the end of efficient markets theory? - FT Alphaville
Oil, the great inflation hedge - FT Alphaville
A commodity anchor, or oil as money - FT Alphaville
BNY Mellon’s fx team: Ultimately, buy gold - FT Alphaville

This entry was posted by Izabella Kaminska on Tuesday, May 19th, 2009 at 13:57 and is filed under Capital markets, Commodities. Tagged with Dollar, inflation, WTI."

coming from Japan’s opposition party — which isn’t exactly steaming ahead towards victory

TO BE NOTED: From Alphaville:

"Samurai-ed: Japan ‘would avoid dollar bonds’ Posted by Tracy Alloway on May 13 10:12.

Japan voiced some anti-dollar/US Treasuries remarks and a future preference for samurai bonds late Tuesday.

From the BBC:
Japan’s opposition party says it would refuse to buy American government bonds denominated in US dollars, if elected.

The chief finance spokesman of the Democratic Party of Japan, Masaharu Nakagawa, told the BBC he was worried about the future value of the dollar. Japan has been a major buyer of US government bonds, helping the US finance its Federal budget deficits.

But, he added, it would continue to buy bonds only if they were denominated in yen - the so-called samurai bonds.

Yen-denominated bonds would effectively mean that the US is exposed to the risk of future falls in the value of the USD rather than Japan. That’s a pretty big policy shift for Nippon, which has been a strong buyer of US Treasuries - and, taken with comments coming out of China, hints at a growing unease in Asia over the USD’s supremacy.

But, as the BBC story notes, this is coming from Japan’s opposition party — which isn’t exactly steaming ahead towards victory. Nakagawa’s comments have also been toned down since his interview with the BBC, and there is, as often happens with Japanese politics, undoubtedly a dose of anti-gaijin political rhetoric in the above. BarCap has a good summary:
Masaharu Nakagawa, the “shadow” finance minister of Japan’s largest opposition party, the Democratic Party of Japan, was quoted by BBC on 12 May saying that his party would shun buying US bonds denominated in dollars if his party took the reins of government as a result of Japan’s upcoming lower house election. In an interview with Bloomberg News on 13 May, however, Mr. Nakagawa clarified that it would merely be one option for Japan to propose that the US government issue samurai bonds (US bonds denominated in yen), and that this was strictly his personal proposal and would not necessarily be implemented immediately by the party if it took the helm. The comments, while perhaps reflecting a genuine concern shared by other world leaders, would also serve to boost Mr. Nakagawa’s nationalist credentials ahead of the election and, we believe, should be viewed primarily in that context. Japan’s lower house election must be held by this September, but could be called earlier if the prime minister decides to dissolve the lower house prior to that time.

The samurai will be waiting for a while, it seems.

Related links:
Samurai bond market revives - FT
China to US: We hate you - FT Alphaville
We ‘hate you guys’ even more now… - FT Alphaville

This entry was posted by Tracy Alloway on Wednesday, May 13th, 2009 at 10:12 and is filed under Capital markets, People. Tagged with china, Dollar, japan, Treasuries, yen."

The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse

From Naked Capitalism:

"Andy Xie: "If China loses faith the dollar will collapse"

It's easy for Americans to pooh-pooh bearish talk about the dollar. Yet the sterling was once the reserve currency, and has fallen, what, by 80% since it lost its standing.

With increasingly dubious accounting and lax enforcement, the US capital markets no longer stand out by virtue of being better regulated. Yes, they still may be deeper and more liquid. But overseas buyers have to look hard at foreign exchange risk. The direction for the dollar in the long term is certain to be down. Overextended debtors trash their currencies (see the Great Depression, the Nordic and Swedish banking crises, and the Asian crisis for a few of many examples).

What is interesting about the Xie piece is that even the stalwart Chinese retail investor has become leery of the dollar. Despite th logic of "oh if you sell, you only hurt yourself", the flip side is if you become certain you are indeed holding a depreciating asset, it makes sense to exit. You want to be early, not late, out.

And that logic, if it starts to take hold, in classic run on the bank fashion, could lead to a disorderly fall in the dollar. It isn't clear what the trigger might be, but Bob Shiller contends that sudden flights from markets don't necessarily require an event to kick them off. And given that Willem Buiter, who though fond of colorful writing, is hardly an extremist, foresees a collapse in dollar assets if the US fails to contain its fiscal deficit, talk of a dollar plunge isn't a a radical view.

From the Financial Times:

Emerging economies such as China and Russia are calling for alternatives to the dollar...Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets...

....emerging economies...have amassed nearly $10,000bn (€7,552bn, £6,721bn) in foreign exchange reserves, mostly in dollar assets. Any other country with America’s problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world’s dominant reserve currency. The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse.

The faith of the Chinese in America’s power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar’s global status. Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets....

The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility. The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy ethnic Chinese tend to send their children to the US for education. They treat the dollar as their primary currency.

The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts rather than on dubious spending to prop up the economy. When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. The country’s vast and unexplored natural resource holdings could be auctioned off. Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out.

The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings. Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies. Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.

Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. China’s bulging foreign exchange reserves reflect the lack of private demand for dollars...

America’s policy is pushing China towards developing an alternative financial system. For the past two decades China’s entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar. The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces. This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China’s dual approach to be effective; its inefficiency was masked by bubble-generated global demand.

China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse."

Me:

Don said...

"America’s policy is pushing China towards developing an alternative financial system."

China has two main complaints against the US:
1) We're using our currency to help us get out of this crisis
2) We don't guarantee assets, such as bonds
They have already taken numerous steps:
1) Swap lines in their own currency
2) A regional bailout fund
3) Telling everyone that we're unreliable, and it's working

Although we are still a flight to safety port, the flight from agencies to treasuries, from implicit to explicit guarantees, was not a good deal for us. It was a deflationary move of some magnitude, and showed the beginnings of lack of trust in us.
Oddly, Geithner's mocked total guarantee is exactly what the Chinese wanted and expected. China believes that being the economic powerhouse brings with it certain responsibilities. In the Asian Crisis, for example, China believes that it never used its currency for its benefit, or reneged on deals. The Chinese claim that this is acting responsibly, while we, in this crisis, are not.
The threat of defaulting on bonds, loans, especially if we are de facto running or backing these companies, is very irresponsible from the Chinese perspective.
Truly, the Chinese are making headway in this crisis worldwide in portraying us as irresponsible, and not worthy of having the position in the world financial system that we do. It will matter going forward because of foreign investment, and the desire for US goods.
But hey, let's keep telling ourselves that we have the upper hand, right up until the point that we don't. If people don't believe that much of the world blames us for this crisis, they're going to be in for a rude awakening. Solving our crisis at the expense of foreign countries and investors seems a really poor move.

Don the libertarian Democrat

May 5, 2009 10:33 AM

From the FT:

"If China loses faith the dollar will collapse

By Andy Xie

Published: May 4 2009 19:28 | Last updated: May 4 2009 19:28

Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the Federal Reserve’s liberal policy of expanding the money supply to prop up America’s banking system and its over-indebted households. Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves.

The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have amassed nearly $10,000bn (€7,552bn, £6,721bn) in foreign exchange reserves, mostly in dollar assets. Any other country with America’s problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests. But the US situation is unique: it borrows in its own currency, and the dollar is the world’s dominant reserve currency. The US can disregard its creditors’ concerns for the time being without worrying about a dollar collapse.

The faith of the Chinese in America’s power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar’s global status. Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets. You have to check the asset allocations of wealthy ethnic Chinese to understand the dollar’s unique status.

The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility. The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy ethnic Chinese tend to send their children to the US for education. They treat the dollar as their primary currency.

The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts rather than on dubious spending to prop up the economy. When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. The country’s vast and unexplored natural resource holdings could be auctioned off. Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out.

The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings. Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies. Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.

Diluting Chinese savings to bail out America’s failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar’s global status. Ethnic Chinese demand for the dollar has been waning already. China’s bulging foreign exchange reserves reflect the lack of private demand for dollars, which was driven by the renminbi’s appreciation. Though this was speculative in nature, it shows the renminbi’s rising credibility and its potential to replace the dollar as the main vehicle of wealth storage for ethnic Chinese.

America’s policy is pushing China towards developing an alternative financial system. For the past two decades China’s entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar. The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces. This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China’s dual approach to be effective; its inefficiency was masked by bubble-generated global demand.

China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China’s anxiety over relying on the dollar system. The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system. When that happens, the dollar will collapse.

The writer is an independent economist based in Shanghai and former chief economist for Asia Pacific at Morgan Stanley"

And:

Don said...

Walter,

Yes. That's why I said 'believe'. Let me get you the best place that they've argued this:

http://www.pbc.gov.cn/english//detail.asp?col=6500&ID=138

"2. The role and contribution of China, as a responsible big country, in Asian financial crisis

In order to mitigate the impact of Asian financial crisis and help crisis-stricken Asian countries walk out of the plight, then China's Premier Zhu Rongji promised, on behalf of the Chinese government, to the world that the RMB would not depreciate, followed by a series of active measures and policies.



(1) China made vigorous efforts to participate in the IMF's rescue operations to help related Asian countries. After the outbreak of financial crisis, under the arrangement framework of the IMF, the Chinese government provided a total of over US$4 billion assistance to Thailand, as well as export credit and emergency free medicine assistance to Indonesia and other East Asian countries, although China had inadequate foreign exchange reserves at that time.



(2) China actively cooperated with relevant parties to participate in and advance regional cooperation. At the sixth ASEAN informal leaders' meeting, then China's President Jiang Zhemin unveiled three proposals of strengthening regional cooperation to refrain the crisis from spreading, reform and improve international financial system, and respect self-selected measures of relevant countries and areas to overcome financial crisis. At the second informal ASEAN+China, Japan and Korea leaders' meeting and the informal ASEAN+China leaders' meeting, then Vice President Hu Jintao emphasized that East Asian countries should vigorously engage in reform and adjustment of financial system, with the most pressing need to intensify the management and supervision over short-term capital flow. He called on the East Asian countries to strengthen exchange on macroeconomic issues such as financial reform, have dialogue between deputy finance ministers and deputy governors of central bank, and form expert team at appropriate time to launch in-depth research on specific measures on managing short term capital flow. The above measures adopted by the Chinese government received positive response and support from most crisis-stricken countries.



(3) China promised that the RMB would not depreciate. Being a highly responsible country, the Chinese government made the decision of no depreciation of the RMB with an aim of safeguarding regional stability and promoting development, which played a pivotal role in maintaining economic and financial stability of the Asian countries and the world at large, as well as Asian countries' economic recovery and regaining of rapid growth in later years.



(4) China implemented policies to boost domestic demand and stimulate economic growth. While sticking to no depreciation of the RMB, the Chinese government took a wide range of measures to boost domestic demand and stimulate economic growth, which safeguarded health and stability of domestic economic growth, mitigated difficult situation in the Asian economies, and fueled recovery of Asian economy.



The adoption of these measures by the Chinese government embodied that as a part of Asia, China had a full awareness of collective interests and responsibility and has made its due contribution to the rapid recovery and regaining of growth momentum of the Asian economy."

Now, of course, there's something amusing about China saying that it doesn't use currency considerations in its planning. However, they're making a more salient point, which is that they did not use their currency for their own advantage during a crisis.

Bottom line, whether true or not, China is getting very good at playing the capitalist game very fast. They have problems, but, even so, they do make some at least plausible sounding criticisms against the US in this crisis.

Take care,

Don the libertarian Democrat

Big conversions by China or another large holder, or even market fears thereof, could trigger a massive run on the dollar.

TO BE NOTED: From the FT:

"We should listen to Beijing’s currency idea

By Fred Bergsten

Published: April 8 2009 20:12 | Last updated: April 8 2009 20:12

Zhou Xiaochuan, governor of China’s central bank, has suggested creating a “super-sovereign reserve currency” to replace the dollar over the long run. He would sharply enhance the global role of special drawing rights, the inter­national asset created by the Inter­national Monetary Fund in the late 1960s and just given an enormous boost by the decision of the Group of 20 to expand its issuance by $250bn (€189bn, £171bn). These are the first big proposals for international monetary reform from China or indeed any emerging market economy and deserve to be taken seriously for that reason alone.

Several other Asian countries, Brazil and Russia have expressed support for Mr Zhou’s ideas. The US and several other governments, however, have been quick to reject them, reaffirming their confidence in the central global role of the dollar. They apparently fear that serious discussion of this issue could shake confidence in the dollar, driving down its value and prompting a sharp rise in the euro and other currencies. Such instability and consequent rise in global interest rates would severely complicate US, European and global recovery from the crisis.

But there is a more immediate threat to financial stability from the global role of the dollar that could be significantly reduced by pursuing a more limited proposal made by Mr Zhou. The risk is that China and perhaps other monetary authorities, together holding more than $5,000bn in dollar reserves, will lose confidence in the dollar owing to the prospects for huge and sustained budget deficits in the US. Premier Wen Jiabao recently expressed such concerns in a highly unusual public statement, asking for “guarantees” of China’s dollar holdings that recall the British demand for a guarantee in 1971 that triggered the US decision to break the dollar’s link to gold.

These worried dollar holders have refrained from dumping Treasury securities only because the dollar has strengthened over the past year – which is almost certainly a temporary phenomenon – and because of the adverse global repercussions. We ignore at our peril the prospect that they may feel compelled to do so, especially if the US were to provoke the Chinese by taking aggressive trade policy actions against them. Big conversions by China or another large holder, or even market fears thereof, could trigger a massive run on the dollar.

Mr Zhou proposes to alleviate this problem by creating “an open-ended SDR-denominated fund” at the IMF into which dollar balances could be exchanged for SDRs. This is essentially the substitution account idea negotiated in the IMF in the late 1970s and for which detailed blueprints were developed. Similar anxieties about the dollar at that time prompted its sharpest plunge in the postwar period, intensifying the double-digit inflation and soaring interest rates that brought on the deepest US slowdown since the 1930s, until now.

I set out how the idea would work in an article on these pages in December 2007, in which Chinese officials displayed considerable interest. Instead of converting unwanted dollars through the market, official holders would deposit them in a separate IMF account for SDR. Their new asset would be liquid and pay a market rate of return. It would offer the desired diversification as the SDR is denominated in a basket of currencies – 44 per cent dollars, 34 per cent euro and 11 per cent each of yen and sterling.

The substitution account would be a winning proposition for all concerned. The dollar holders would obtain instant diversification. The US would avoid the risk of a free fall of the dollar. Europe would prevent a sharp rise in the euro. The global system would eliminate a potential source of great instability. These benefits call for the use of a global asset to make up any losses to the account from future falls in the dollar, such as creation of additional SDR or the IMF’s gold holdings (including the sizeable US share of them).

The main argument against such an account is that China has accumulated its dollar hoard of more than $1,000bn by keeping its currency substantially undervalued, through massive intervention in the foreign exchange markets, and thus deserves no sympathy if it takes losses on those dollars. One might even suspect that the Chinese have mentally booked such losses as the implicit cost of the subsidy to exports and jobs achieved through their currency manipulation. But there is no sign that China will stop intervening, or that its surpluses will abate, even though the US external deficit has declined sharply, and its reserve build-up is thus likely to become even more threatening.

Moreover, this is an ideal issue for China and the US to develop the informal “G2” partnership that is needed to provide global economic leadership to pass needed reforms at the existing multilateral institutions. Since China advocates currency consolidation, the US could insist that it contribute substantially to the IMF’s new lending facilities as a quid pro quo. The Europeans would have to concur, since the agreement would include a large increase in China’s voting rights at the IMF, where Europe is so heavily over-represented, but China-US agreement would go far to seal the deal.

The writer is director of the Peterson Institute for International Economics. He was assistant secretary of the Treasury for international affairs in 1977-1981 and led the substitution account negotiations for the US in 1980"

“That is largely reflected in increased risk appetite.”

TO BE NOTED: From Bloomberg:

"Yen Weakens Above 100 per Dollar as G-20 Aid Saps Safety Demand

Share | Email | Print | A A A

By Theresa Barraclough and Ron Harui

April 3 (Bloomberg) -- The yen weakened to above 100 per dollar for the first time in five months as the Group of 20 nations pledged to revive economic growth and on speculation the Federal Reserve will step up efforts to counter the U.S. slump.

The yen also fell to a five-month low against the euro and the Australian dollar as stocks rallied, increasing demand for higher-yielding assets. The euro is poised for a weekly gain against the dollar on speculation a European Central Bank official will signal the bank is done cutting interest rates after yesterday lowering them by less than economists expected.

“The market thinks the world is suddenly a better place,” said Sue Trinh, a senior currency strategist at RBC Capital Markets in Sydney. “That is largely reflected in increased risk appetite.”

The yen touched 100.18 per dollar and traded at 99.71 as of 10:55 a.m. in Tokyo, after falling 1 percent yesterday. Japan’s currency weakened to 134.04 per euro, from 133.98 yesterday in New York, when it dropped 2.6 percent, the most in five weeks. The yen is set for a 3.1 percent slide versus the euro this week.

Europe’s single currency traded at $1.3446, up 1.2 percent this week. Australia’s dollar rose to 71.39 yen, after reaching 72.33, the highest since Oct. 21, as a report showed the nation’s services industry shrank last month at a slower pace. The New Zealand dollar advanced to 58.43 yen, after reaching 59.03, the highest since Nov. 10.

Group of 20

The yen weakened against all 16 major currencies this week as world leaders agreed on measures to fight the global recession.

Policy makers from the Group of 20 nations called for stricter limits on hedge funds, executive pay, credit-rating firms and risk-taking by banks. They also tripled the firepower of the International Monetary Fund and offered cash to revive trade to help governments weather the turmoil resulting from the surge in unemployment.

“The G-20 summit could mark a turning point in the global financial crisis,” wrote analysts led by Callum Henderson, global head of foreign-exchange research at Standard Chartered Bank in Singapore, in a note today. “This should be supportive for high-yielding currencies such as the Australian dollar in the near term.”

Asian stocks jumped, with the regional benchmark index headed for its fourth weekly advance, following a rally yesterday in U.S. stocks that pushed the Dow Jones Industrial Average above 8,000 for the first time since Feb. 10.

Further Steps

Japan’s currency fell for a second day versus the greenback on expectations Fed Vice Chairman Donald Kohn may add to measures to revive the world’s second-largest economy, reducing demand for the currency as a shelter from the global crisis. Kohn speaks at 9:10 a.m. in Ohio.

The VIX volatility index, a Chicago Board Options Exchange gauge reflecting expectations for stock price changes that’s used as a measure of risk aversion, fell 0.6 percent yesterday, the third day of declines.

The euro gained against the yen as European policy makers cut the target lending rate by a quarter-percentage point to 1.25 percent, compared with a half-point reduction expected in a Bloomberg survey. Benchmark rates are 0.1 percent in Japan, 0.5 percent in the U.K. and between zero and 0.25 percent in the U.S.

“Interest-rate differentials between the euro zone and other nations such as the U.S. are still favorable for the euro,” said Masanobu Ishikawa, general manager of foreign exchange at Tokyo Forex & Ueda Harlow Ltd., Japan’s largest currency broker. “This makes it easy to buy the euro,” which may rise to $1.3550 and 135.00 yen today, he said.

‘Increasingly Benefit’

ECB President Jean-Claude Trichet indicated at a press conference in Frankfurt following the decision that the economy should “increasingly benefit” from the measures the central bank has taken.

Executive Board Member Lorenzo Bini Smaghi last month said European interest rates are lower than those in the U.S. when making a comparison of real inter-bank lending, adding to the argument against further reductions in the benchmark. He speaks at 11 a.m. in Rome.

Declines in the yen may be limited before a U.S. Labor Department report shows the world’s biggest economy lost more than half a million jobs for a fifth month, reducing the appeal of the greenback.

“There’s a risk of position adjustments before the U.S. labor report, which may prompt buying back of the yen,” said Masafumi Yamamoto, head of foreign-exchange strategy for Japan at Royal Bank of Scotland Group Plc in Tokyo and a former Bank of Japan currency trader.

U.S. Unemployment

U.S. employers probably eliminated 660,000 jobs last month, following a reduction of 651,000 in February, according to the median forecast of 80 economists surveyed by Bloomberg. The Labor Department is scheduled to release the report at 8:30 a.m. in Washington.

The Dollar Index, which the ICE uses to track the greenback against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, decreased 0.1 percent to 84.368, and is poised for a 1 percent weekly decline."

contrary to mechanistic arguments that savings rates can be influenced by policy, the Chinese propensity to save has cultural roots

TO BE NOTED: From the FT:

"China is just sabre-rattling over the dollar

By David Pilling

Published: April 1 2009 19:19 | Last updated: April 1 2009 19:19

A few weeks ago, five Chinese vessels, two of them fishing trawlers, surrounded a US naval ship, the Impeccable, off Hainan island in the South China Sea. When the US survey ship responded with fire hoses, the Chinese crewmen stripped down to their underwear and – according to some reports – bared their bottoms.

The slightly surreal stand-off, which drew a sharp protest from Washington, was carefully calibrated. Though it fell well short of a military exchange, it nevertheless sent a message that Beijing was not prepared to tolerate routine US spying missions in waters it considers its own.

In the more cerebral world of monetary policy, Zhou Xiaochuan, China’s central bank governor, has sent a carefully calibrated signal of his own. While he stopped short of baring his bottom, he published a paper, neatly timed to appear just before the Group of 20 developed and emerging nations summit, in which he proposed replacing the dollar with an international reserve currency. In a detailed and serious analysis, he suggested expanding the scope and function of special drawing rights, a unit of account used by the International Monetary Fund.

Mr Zhou’s proposal did not emerge from thin air. In recent weeks Beijing has been vocal about its concerns over the US dollar, a currency that it fears could be debased by ever more wanton printing to rescue a worn-out economy. Wen Jiabao, China’s premier, referring to the fact that 70 per cent of China’s almost $2,000bn (€1,500bn, £1,400bn) in foreign reserves is held in dollars, said: “To be honest, I am a little bit worried. I request the US to maintain its good credit, to honour its promises and to guarantee the safety of China’s assets.”

Beijing has simultaneously been taking cautious steps to make its currency more internationally relevant. This week, Mr Zhou signed a Rmb70bn ($10bn, €7.7bn, £7.1bn) currency swap deal with Argentina, designed to allow the Latin American nation to settle some trade bills in renminbi. It followed swaps with South Korea, Malaysia, Indonesia, Hong Kong and Belarus.

There is much substance to Mr Zhou’s proposals. Arthur Kroeber of Dragonomics, a research company in China, argues that Beijing is staking out a responsible position whereby it seeks a multilateral alternative monitored by a multilateral body. It does not want to challenge the dollar but is serving notice that, over time, the world should diversify from overdependence on one currency.

China, which is being asked to stump up more money for the IMF, would also like to ensure that it is not bankrolling a has-been institution. If it funds the IMF, it would like something in return.

Yet neither is the proposal entirely what it seems. Like the naval skirmish, there is an element of bravado. Beijing is signalling that US hegemony, while it cannot yet be seriously challenged, cannot last forever. The idea of questioning the dollar’s pre-eminence has received backing from other nations with agendas of their own. Russia has proposed something similar. Hugo Chávez, South America’s gringo-basher-in-chief, supports Beijing’s stance and suggests that a new supra-currency be backed by oil reserves, his own included.

That there is an element of theatre to Beijing’s proposal can be deduced from several factors. First, few people, not even Mr Zhou, can really expect the SDR to play the role of über- currency. To be credible, the issuing institution, the IMF, would have to run a central bank. It might also need, with due respect to the Swiss franc and the Japanese yen, to back its currency with an army and navy.

Second, it is clear that China’s currency ought to play a bigger international role. But the main obstacle to that is not in Washington. If China’s currency were fully convertible, other countries would doubtless already be holding a small, but respectable, proportion of their foreign reserves in renminbi, much as they already do with the euro and the yen. Mr Zhou’s remarks offer the faintest hint that Beijing may consider convertibility marginally sooner than many have been assuming. But fears of capital outflows and wild, export-damaging swings in the renminbi mean that is still likely to be years away.

Third, Beijing’s nightmares of a sudden fall in the dollar depleting its foreign reserves are overdone. It is true the government has been heavily criticised for ill-timed purchases of equity stakes in western banks. But China’s holdings of US Treasuries are not an investment. Unless Beijing is seriously considering selling down its US assets, a fall in the dollar would produce purely theoretical losses.

That leads to the final point. Mr Zhou’s paper distracts from the fundamental point that China would not have huge dollar holdings if it had not pursued specific policies – namely export-led growth predicated on a competitive renminbi.

Shortly after his paper on the end of the dollar, Mr Zhou published his thoughts on high savings rates, the flip side of US borrowing. China resents suggestions that its “excess savings” are linked to excess spending elsewhere. In his paper, Mr Zhou argues that, contrary to mechanistic arguments that savings rates can be influenced by policy, the Chinese propensity to save has cultural roots, specifically a Confucianism that “values thrift, self-discipline ... and anti-extravagancy”.

Such deep-seated habits are, by definition, extremely hard to change. The message is clear. It is America that must budge."

Chinese policy makers increasingly seem to view China’s large reserves as a burden, not as an opportunity.

TO BE NOTED: From Follow The Money:

"The PBoC’s call for a new global currency, the SDR, the US and the IMF

Posted on Sunday, March 29th, 2009

By bsetser

A $200 billion shared pool of reserves ($250 billion counting the IMF’s supplementary credit line) is tiny relative to the world’s $7000 billion in national reserves, or — more importantly — relative to the emerging world’s short-term external debt. The IMF currently lacks enough funds to be a lender of last resort for Eastern Europe, let alone the world. George Soros:

“capital is fleeing the periphery and it is difficult to rollover maturing loans. …. To stem the tide, the international financial institutions (IFIs) must be reinforced … the fact is that the IMF simply doesn’t have enough money to offer meaningful relief. It has about $200 billion in uncommitted funds at its disposal, and potential needs are much greater.”

A bigger IMF implies a somewhat larger role for the IMF’s unit of account: the Special Drawing Right (SDR), itself a basket of dollars, euros, pound and yen. When the IMF lends, its loans are denominated in SDR – not dollars, euros or yuan. China may argue that SDR-denominated lending is the first step toward creating a new “supranational” reserve currency. But that is a stretch. No one made such an argument back when the IMF was making a lot of SDR-denominated loans to Asia in the 1990s.

The IMF pools contributions from many countries, so denominating its accounts in a composite of the world’s main currencies make sense. Using the SDR inside the IMF isn’t a threat to the US dollar either. Last I checked, the dollar has somehow managed to maintain its position as the world’s leading reserve currency even though United States’ contribution to the IMF (its quota) is measured in SDR.

Indeed, the SDR – as the IMF explicitly recognizes on its website – isn’t actually a currency.

“The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.”

Countries intervene in the foreign exchange market with dollars and euros not SDR. An IMF loan is just denominated in SDR – so the amount a country has to repay doesn’t change all that dramatically when the dollar moves v the euro. In practice countries actually want to borrow “freely usable currencies” not SDR. In other words, they generally want dollars and euros.

As Dan Drezner observed, many traders presumably hadn’t read Governor Zhou’s white paper or spent much time brushing up on the mechanics of the SDR . They consequently read a bit too much into the headline that was slapped onto Geithner’s comments at the Council. Macroman is right:

“Geithner said that …. he was certainly open to expanding the pool of IMF SDRs. This was an innocuous enough comment, as the IMF is likely set to see its funding levels increase dramatically.”

Deal Journal is wrong; Geithner never said he was only open to “abandoning the U.S. dollar as the primary global reserve currency.” He was open to increased “use of the IMF’s special drawing rights” but he also said this was “rather evolutionary, building on the current architectures, than — rather than — rather than moving us to global monetary union.”

Indeed, Zhou’s call for a one time SDR allocation (an SDR allocation is complicated ** but it effectively is a way for the advanced economies to help meet emerging economies need for hard currency reserves) is less radical than Martin Wolf’s call for an annual SDR allocation. Soros also wants an annual allocation as long as the crisis lasts. Wolf hopes an annual SDR allocation would allow emerging economies to build up reserves without running large current account surpluses.

A one time SDR allocation to increase the emerging world’s access to dollars and euros (the main current reserve currencies) is quite different than redenominating all of the world’s reserves into SDR. The world’s reserves couldn’t actually be redenominated in SDR unless the US and a host of eurozone countries started issuing a ton of SDR debt to replace all the dollar-denominated Treasuries and euro-denominated bunds, OATs and BTPs*** — now held as part of the world’s reserve portfolio. That isn’t about to happen.

I am still struggling to understand precisely what motivated Governor Zhou’s white paper.

One possibility is that he wanted to highlight the fact that the IMF doesn’t operate in dollars to help “sell”a bigger Chinese contribution to the IMF at home. Zhou can argue that China isn’t handing dollars over to a US dominated institution, as some might think. Or helping to bail out a bunch of countries in Eastern Europe peripheral to China’s national interest. By providing the IMF with SDR, China can argue that it is contributing in a small way to the creation of a new reserve currency.

The Journal’s Batson hints as such a motivation when he reports:

“China has resisted the U.S. push to make an immediate loan to the IMF because that wouldn’t give China a bigger vote. Ms. Hu said Monday that China, which encourages the IMF to explore other fund-raising options, would consider buying into a bond issue. The IMF has been working on a proposal to issue bonds, probably only to central banks”

Of course, Zhou’s call for a new global reserve currency was also intended to signal China’s concern about the direction of US policies. And just perhaps, to signal that China’s government is taking domestic criticism that it has squandered China’s savings to heart.

It some ways Zhou’s call is a sign of weakness as much as a sign of strength, as China’s leaders are now is clearly worried about the value of its reserve portfolio. Or perhaps they are just worried about being blamed for losses on China’s reserve portfolio.

Chinese policy makers are sophisticated enough to know that the US is not going to embrace a true supranational currency. Agreeing to a world where the IMF calculate its accounts in a basket of dollars, euros, pound and yen is one thing. Agreeing to a new currency that supersides the dollar is quite another.

Moreover, China’s call for a change in the global order is rather undermined by China’s ongoing desire to peg to the plain old dollar.

A discussion of reserve currencies ultimately is also a discussion about the exchange rate regimes that led a host of emerging economies to accumulate reserves. Zhou’s call puts some issues that China hadn’t wanted to discuss at the last leaders meeting on the table for international discussion.

Perhaps China’s leaders wanted to insulate their dollar peg from criticism, both at home and abroad, by arguing that they cannot change their peg without a broader change in the international monetary regime. China can argue that if the US doesn’t want to abandon the dollar, China shouldn’t be pushed to abandon its dollar peg.

The only problem is that there is no real link between the two issues. China could easily join those emerging economies that already allow their currencies to float against the dollar and the euro even in the absence of any agreement on a new global currency.

In a lot of ways, though, the most surprising proposal in Zhou’s paper wasn’t his call for a new global currency; it was his call for “international” management of national reserves. Zhou wrote:

Compared with separate management of reserves by individual countries, the centralized management of part of the global reserve by a trustworthy international institution with a reasonable return to encourage participation will be more effective in deterring speculation and stabilizing financial markets …. With its universal membership, its unique mandate of maintaining monetary and financial stability, and as an international “supervisor” on the macroeconomic policies of its member countries, the IMF, equipped with its expertise, is endowed with a natural advantage to act as the manager of its member countries’ reserves

That would really be a change. China currently isn’t willing to tell the IMF the currency composition of its reserves. And now it seems to be hinting that it might allow the IMF to manage a portion of its reserves!****

Chinese policy makers increasingly seem to view China’s large reserves as a burden, not as an opportunity.

Unfortunately, China is already stuck with this burden. In some sense, the current debate in China over the cost of maintaining a large reserve portfolio is a debate China should have had four or five years ago. Back then it was clear that China had put itself on a path that would lead it to accumulate huge reserves at a substantial cost to itself. It didn’t change though. As a result, it ended up providing a lot of dollar-denominated credit to the US over the last four years.

Now it is struggling to accept the consequences of the policy choices that left it with over 50% of its GDP in reserves or quasi-reserves.

That presumably is why previously unthinkable options – like global management of China’s reserves – seem to be getting serious consideration.

*”Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.”
** As I understand it, the IMF grants all countries SDRs. And then emerging economies can use their SDRs as collateral to borrow dollars and euros and the like from the central banks of the world’s advanced economies. It is a way countries that don’t have currencies of their own that the Fed is willing to accept as collateral in swaps can get hard currency reserves. If there is a better explanation, I am all ears.
*** German, French and Italian government bonds
**** Dr. Summers, in his academic days, made a similar proposal."

“We have been talking about the risk of the dollar and dollar devaluation for a long time,”

TO BE NOTED: From Real Time Economics:

"Fan Gang on the China-Dollar Conundrum

From the WSJ’s China Journal blog:

Associated Press

General Manager of the Bank for International Settlements Malcolm Knight and Fan Gang, director of the National Economics Research Institute, in 2006.

The pan-Pacific debate over the dollar’s standing as a global currency continues. On Tuesday, U.S. President Barack Obama dismissed suggestions raised by China’s central bank governor that the world needs a new international currency that can take the place of the dollar in international reserves. Fan Gang, a prominent economist and advisor to China’s central bank, watched Obama on CNN in his Hong Kong hotel room, but says he was hardly convinced.

“Of course” an alternative is necessary “in the long run, if we want to avoid the cyclical problems associated with the dollar standard,” Fan says in an interview with the Journal on Wednesday. Besides being director of China’s National Economic Research Institute, a nongovernment think tank, Fan sits on the monetary policy committee of the People’s Bank of China, which means his views carry some weight in Beijing.

Fan describes the dollar as a kind of transmission mechanism for risk. The current crisis, he says, may have begun in the U.S. and Europe, but because of the dollar standard, “the risk of highly leveraged institutions has spread to other countries.”

The onus therefore is now on the U.S. in particular to better regulate its banks and hedge funds for the sake of the global economy, he believes. Next, Fan says, “we should monitor capital flows, and monitor leverage, and this information should be reported to the countries where (institutions) are investing.”

International trade in goods is heavily monitored and regulated, says Fan. It therefore makes no sense that “you have a regulated real market and an unregulated financial market.”

Of course, China is pretty good at keeping a close eye on capital flows. It allows only limited convertibility of its currency, the yuan, and tightly restricts foreign investment in the country’s capital markets. Fan, who asserts that “Chinese prudence has paid off,” says capital controls are “better for developing markets.”

(Later, speaking at a Credit Suisse investment conference here over lunch, Fan reiterated his line about prudence paying off. Privately, one critic in the audience quietly scoffed. China happily financed the U.S. trade deficit by buying low-yielding Treasurys for years, he said. How prudent was it to offer cheap vendor financing to a big customer with a lot of debt?)

Fan says while China is eager to keep its currency stable, there is pressure to let the yuan fall — “not just domestic pressure, but regional pressure,” as other Asian currencies weaken, making them more competitive. Rather than let the yuan fall against the dollar, he suggests that China should make reference more to the other currencies in the basket it uses to set the yuan’s exchange rate. “Eventually, China’s currency should be related to other currencies, not just the dollar,” he says.

Fan worries that the Fed’s quantitative easing is raising the risk of dollar inflation and devaluation, which “is a concern not just for China but for everyone.” He also believes monetary problems will fuel more “China bashing” in the U.S. from members of Congress that have previously railed against China’s currency policies. “In the future, you will see, when the dollar devalues, these senators will come back,” says Fan. Interestingly, Fan’s excitement level seems to peak when he’s asked why China is choosing to speak up now about the dollar.

“We have been talking about the risk of the dollar and dollar devaluation for a long time,” he says. “We have been talking about U.S. causes behind the imbalances in the trade deficit. No one listened. This is a time to get noticed.”

The mindset change could see a reversal over the next few months of the larger "safe haven" trend as investors pile back into the risky foreign assets

From Zero Hedge:

"The First Two Rules Of Zero Hedge...

Posted by Tyler Durden at 3:25 PM

...have been broken. However the end result is welcome as I present to you the first Zero Hedge recruit, Cornelius. Cornelius has an exciting and very pertinent background, packs a mean financial punch, and will focus on a space that I have not been able to devote much time or attention to: global macro with a focus on FX and commodities.

Please welcome him to the club.

The Currency Week In Review
By Cornelius

The big news in FX markets last week was the post-FOMC announcement that the Fed was going to buy back $300B of US long treasuries. The pattern was consistent across the major currency pairs - the USD got hammered from peak to trough to the tune of roughly 500-700 pips from the initial sell-off, a brief profit taking period and another mini sell-off the next day. This is a significant event for two reasons: one, the FX markets were clearly not pricing in any expectations of this and two, this event jarred the trend over the past few months of USD strengthening on the back of the "safe haven" theory.







In the 10-year history of the Euro, Wednesday was the largest single day jump for the EUR/USD currency pair. The FX markets were anticipating a largely quiet Wednesday, expecting the Fed to maintain the Fed Funds rate in the 0-0.25% target range. However, the announcement of the buyback rocked the markets as the consensus view was that the Fed was limiting itself to the conventional monetary policy tools and was constrained by an already bloated balance sheet. The Fed's actions showed a willingness to battle the recession at all costs and showed the FX markets to be badly out of synch with this mentality. This is significant, because going forward the markets will more closely track to the expectations of the Fed's view of the US recovery and the resulting potential balance sheet actions. Given that the Fed funds rate is not likely to change over the next 6 months, currency market watchers should pay very close attention to the nitty gritty details of credit expansion and the political machinations in DC.

In short, the trick to trading FX has always been to know which number is the key number, to figure out where it's going and to get ahead of it. Wednesday was an inflection point; the key number isn't about guessing a quarter point move in the funds rate, it's now guessing how much more political will does the Fed have to puff up its balance sheet.







In a general trend of risk aversion, the USD has quietly been strengthening over the past 3 months. Despite interest rates being at record lows, investors piled into dollars to avoid the contagion of the global depression and most investors adopted a bunker mentality in their outlook. Wednesday's announcement woke a lot of people up and opened the field for a more risk-friendly attitude. On the "So what?" meter, this is potentially huge. The mindset change could see a reversal over the next few months of the larger "safe haven" trend as investors pile back into the risky foreign assets that they've ditched. This could also be a poor sign for other proxy reserve currencies such as gold and the Swiss franc. The migration back to risk will require a few things, most notably a belief that the Fed can act successfully to get credit flowing and that the resulting lower spreads will be sufficient to justify increased foreign investment. Of course, these are two huge ifs that need to be closely monitored but the Fed's actions are a clear indication that such thinking is at least on the table.

On a separate note, look for the Japanese to strike back over the next 3-6 months. The yen has been gradually weakening and last week's movement are not likely to make the export-crazy Japanese too happy. While there is no official policy statement, the smart money consensus is that the Japanese government has and will engage in open market actions to continue to devalue the yen. Look for the USD/JPY to break the 100 barrier before the summer. Sphere: Related Content

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Monetizing the Debt: Fed Will Buy Everything That's Not Nailed Down (The Prudent Investor - Seeing To..., 3/19/09)

On the Fed's "Shock and Awe" (naked capitalism, 3/18/09)

Dollar Hammered After Fed Announces It Will (Actually) Print Money (Blogging the Commodity Bull Market, 3/19/09)

Read more on Forex, Federal Reserve at Wikinvest

Me:

Don said...

Would your view lead to the conclusion that China will not sell Agencies, but actually consider buying them?

Don the libertarian Democrat

March 22, 2009 4:14 PM

that it has the deepest and most sophisticated bond markets in the world (so there is somewhere to park capital reserves)

From the FT:

"The US dollar, the Norwegian krone and the ‘ugly contest’ Posted by Gwen Robinson on Mar 19 10:43.

All eyes have been on the Fed in the past 24 hours - and all currency gyrations, particularly the dollar’s sharp depreciation - have been attributed to the Fed’s move to spend $300bn on buying long-term Treasuries, among other measures. As some currency analysts observed on Thursday, however, the dollar’s steep decline suggests there may have been some over-reaction to the Fed’s move.

But there are other factors at work behind the dollar’s downward trajectory - not least, growing disenchantment in some parts of the world with US economic policies (or lack thereof), and rumbles about dumping the dollar as the world’s reserve currency and adopting a shared basket of currencies.

In an article about a gathering of top Asian think tanks on Thursday in Tokyo, Reuters reported:
The role of the US dollar as the key global currency will decline after the financial crisis, and its value may also weaken due to America’s current account deficit, officials at some of Asia’s top think tanks said. But Asia, which is heavily invested in US assets, hopes any decline in the dollar will be gradual to avoid further shocks to financial systems, the officials said on Thursday.

The bottom line was summed up by Chalongphob Sussangkarn, a former Thai finance minister and now president of Thailand Development Research Institute, who said:The US deficit is so huge. This is why all countries, particularly East Asia, are concerned because we hold a lot of these assets. What happens if the US dollar falls 40 percent? Many central bankers will be losing huge amounts of money.”

Such fears, now spreading among governments about their relatively large holdings of dollar reserves, have been fuelling moves at the United Nations and there is now growing speculation among analysts and forex markets that the UN is preparing a recommendation to member countries to move away from using the dollar as the world’s reserve currency and instead, adopt a shared basket of currencies. No matter that the UN often appears bureaucratic and ineffectual - it sometimes does make an impact - and almost certainly will if it goes ahead with such a push.

Growing speculation about such an announcement was “as large a reason for the overnight sell-off in the dollar, as was the Fed’s announcement to buy US Treasuries as part of their quantitative easing policy”, noted Richard Grace, CBA’s chief currency strategist in a Thursday note.

While Grace suggests it’s “worth waiting until next week” to see the full intention of the UN’s recommendation to diversify out of dollar, he voices three key reservations about such a move:(1) The UN does not carry as much weight as the G7. If it were a G7 announcement (or even an IMF announcement) then the announcement effect (and the full ramifications) on the USD would be extremely significant (and USD negative). We do not expect such an announcement from the G7 anytime soon.

(2) Most major currency reserve managers already diversify (out of USD) anyway. There is nothing new here. Currency reserve managers will diversify according to liquidity, expected return, and to cover a mix of underlying assets (be it imports or underlying securities). Central bank data from the IMF illustrates that, while there is plenty of room for diversification, a significant amount of reserves are already diversified in non-USD currencies (chart 4).

(3) Most trade contracts and commodity prices are priced in USD. If the UN statement is designed to re-price commodities and trade contracts in an alternative to the USD, and toward a basket of currencies such as Special Drawing Rights (SDR’s), then it is a significant announcement by the UN, and clearly USD negative. But it is worth waiting until next week to see if this is the intention of the UN, and if it has endorsement from the US Treasury. The logistics of such a move are huge and will take some time to implement, but an immediate depreciation of the USD under the above circumstances would certainly occur.

Afterall, notes Grace, the two major foundations which keep the dollar stable as the world’s major reserve currency are first, that the US is the largest economy in the world; and second, that it has the deepest and most sophisticated bond markets in the world (so there is somewhere to park capital reserves). “It takes time for alternative markets to grow and adjust to additional demand”, he noted.

Even so, it’s clear, as the FT reported recently, that countries such as China, which hold massive dollar reserves, are concerned, and that there is some interest in at least radically reducing dollar holdings if not shift out of the dollar as the reserve currency. And as we saw last week, moves by Switzerland to intervene in its currency - and fresh speculation that Japan may go the same route (see Related Links, below) has triggered much discussion within governments about forex holdings and safe-haven currencies.

On top of that is the point made by Morgan Stanley’s Stephen Jen this week, that plans to massively boost the IMF’s funds in order to channel aid to Eastern Europe could ultimately see the euro gaining substantial ground. Still, as Hong Kong-based research and investment house Gavekal remarks in a note on Thursday:

There are numerous reasons to dislike the euro … some valid concerns about sterling and the yen, and, with the Fed clearly indicating its “no holds barred” approach to printing money to spur economic activity, dollar-aversion is no surprise either…

Still, we continue to believe that, warm and fuzzy IMF statements aside, the issues Europe is confronting are very serious and will necessitate a political will and flexibility which we have yet to see on the Old Continent. Thus, of all the three-legged blind mules out there, the euro remains, in our view, the most structurally challenged.

Perhaps, as the FT’s currency correspondent Peter Garnham suggests on Thursday, Norway’s krone may emerge as the big, new safe-haven currency.

The bottom line, as Gavekal concludes, remains that picking a currency has truly become an “ugly contest”. Meanwhile, it says, “away from the spotlight, some currencies either offer tremendous value because they have been oversold concerns about debt exposure (SEK, KRW, IDR…), or because they have sound-enough fundamentals which, in these panicked times, the markets are ignoring (CA$, BRL, MYR…).”

Related links:
Norwegian krone: the new safe haven currency? - FT
Game-changer for the euro, and a coming CHF bloc - FT Alphaville
Getting the IMF to take the heat - FT Alphaville
Ministers agree on need to boost IMF funds - FT
The Swiss franc factor - FT Alphaville
Swiss franc intervention - Short View
Swiss stoke fears of currency wars - FT
On your marks, get set, devalue - FT Alphaville
China’s dollar dilemma - FT

This entry was posted by Gwen Robinson on Thursday, March 19th, 2009 at 10:43 and is filed under Capital markets. Tagged with currencies, Dollar, euro, norway."

Me:

Don the libertarian Democrat Mar 19 14:10

"The US deficit is so huge. This is why all countries, particularly East Asia, are concerned because we hold a lot of these assets. What happens if the US dollar falls 40 percent? Many central bankers will be losing huge amounts of money.”

Isn't the fact that the Flight to Safety necessitated losses when the economy reversed course understood? Surely they knew that it was a hedge against deflation, but that deflation was the one thing that everyone feared and the fight against it would be substantial. I guess what I'm saying is that they don't want to lose money on treasuries, but they want to US economy to strengthen as well, which seem contradictory goals, unless, again, you see the Flight to Safety as a hedge.

Frankly, the fact that there is a focal point for the Flight to Safety might end up being good, as it acted as a kind of LOLR for the world. I'm not sure yet that countries won't want to keep that burden, if you will, on the US, but time will tell.