Are central banks diversifying away from the dollar?
Opinion — informed opinion — is divided.
The currency team at the Bank of New York says yes. Simon Derrick wrote on Monday:
"our own view [is] that one of the driving forces behind the EUR’s sustained strength over the past six years has been reserve diversification (FX reserves globally have all but tripled since the first quarter of 2002)"
Bernhard Eschweiler– the head of JP Morgan's Central Bank Group — says no. He wrote in the FT:
the idea that central banks are undermining the dollar makes neither sense nor is there evidence in the data.
Why? Countries that manage their exchange rate against the dollar are, according to Eschweiler, forced to hold dollars.
The principle mistake that many commentators make is the assumption that central banks can separate the currency allocation of reserves from their exchange rate objectives. In practice, this is often not the case, especially for the large surplus economies in Asia as well as the oil-exporting countries. These countries all follow some sort of dollar standard, whether it is an outright peg or a dirty float.
So, when they intervene to prevent their currencies from appreciating against the dollar, they get mostly – or even exclusively – dollars (also because most of their trade and capital flows are dollar denominated).
However, it is difficult to sell those dollars back to the market without causing renewed dollar weakness and, thus, trigger new interventions. Some small central banks may get away with it, but not the group of large reserve holders. There is no free lunch: if you shadow the dollar you also have to hold it. (emphasis added)
I tend to agree with Mr. Eschweiler. Here is why —
The IMF's data on global reserves provides the starting point for any analysis. Many central banks report data on the currency composition of their reserves. And the IMF sums up all the national data and releases the aggregate sums. That data though has one major drawback — about half of global reserve growth currently comes from countries that do not reporting data on the currency composition of their reserves to the IMF. The countries also account for a rising share of the global stock of reserves.
Nonetheless, it is useful to take a look at what those central banks that do report data have been doing. The following chart plots their total holdings of dollars v the dollar share of their reserves.
The data here is quiet clear. Those emerging economies that report data on the currency composition of their reserves to the IMF did diversify their reserves between early 2001 and the end of 2004. Since the end of 2004, though, the dollar share of these countries reserves has been constant. And their total dollar holdings have increased quite sharply — they are up by roughly $500b since the end of 2004.
This data consequently suggests that diversification played a bigger role in the dollar's 2003 and 2004 slide than in its 2006 and 2007 slide.
One caveat: I doubt the IMF data captures various balance sheet hedges that central banks may have used to reduce their effective dollar exposure. I have no good way of judging the magnitude of such hedges.
The IMF data here also poses a bit of a puzzle, one that I have discussed before.
Russia almost certainly reports the currency composition of its reserves to the IMF (Russia discloses this data publicly, so there is little reason not to report it to the IMF). Russia very clearly reduced the dollar share of its reserves in early 2006. That reduction though doesn't show up in the aggregated data, probably because a set of countries with a very high dollar share have been adding to their reserves very rapidly. Brazil is the obvious candidate.
The IMF doesn't say who reports data on the currency composition of their reserves and who doesn't. But I am certain that China does not report data on the currency composition of its reserves to the IMF, and suspect that the GCC central banks do not either. That is an important gap, as, to quote Mr. Derrick:
"any potential shift in demand from the largest reserve accumulator of all should not be ignored"
So what have China and the Gulf been doing.
Mr. Eschweiler argues that China hasn't been able to reduce the dollar share of its reserves, and may even be increasing the dollar share. The US data, of course, doesn't show such an increase, but as Eschweiler notes, the US data doesn't capture Chinese purchases from banks in Europe and Asia.
And, more crucially, Eschweiler argues that China observed sale of dollars in the market do not seem to have been large enough to keep the dollar share of its reserves from rising. Eschweiler:
A different perspective suggests that China may actually struggle to keep the dollar share from rising since all of its interventions take place in dollars. Over the first half of the year, China’s reserves grew by $270bn.
Thus, to keep the share of dollars at 70 per cent, which is the level most experts agree on, China would have had to sell more than $3bn per week. This is not impossible, but would have stirred up much more market interest than has been observed.
Interesting.
I would note that some of the rapid increase in China's reserves in the first half of 2007 came from the unwinding of swap contracts with the banks and another portion represents valuation gains, so the actual increase in China's foreign assets in the first half was probably somewhere between $200 and $250b, not $270b. But Eschweiler's basic point still holds.
What of the other key part of the dollar zone, the oil-rich countries in the Gulf?
Here there is an added complication. China's reserves are — really were — essentially managed by a single institution, the State Administration of Foreign Exchange. And SAFE reports to the central bank. Up until now, there wasn't much of an issue of policy coordination. The institution that implemented the country's exchange rate policy also managed its foreign assets.
The Gulf's official assets, by contrast, are not managed by a single institution. Each country manages its own assets, and most Gulf countries have both a sovereign wealth fund as well as a central bank. The Emirates has two sovereign wealth funds (one for Abu Dhabi and one for Dubai), "private" fund for Dubai's sheik, a central bank and is considering setting up an Emirati wealth fund as well. There are ten or so government run institutions managing over $10b in foreign exchange. Three manage over $200b — Abu Dhabi's Investment Authority (ADIA), Kuwait's Investment Authority (KIA) and the Saudi central bank (SAMA).
Policy coordination is a real challenge.
Rachel Ziemba and I estimate that the smaller GCC countries — the ones with sovereign wealth funds, transfered roughly $85b of oil revenues to their funds in 2007. ADIA also reinvests the income and on its existing assets and some smaller funds increased their assets under management by borrowing a bit more — so total official asset growth likely will be a bit higher.
Let's say $30b of that was invested in the US. That is just a guess — I certainly am not privy to the Gulf's portfolio allocation. However, it is an informed guess: sovereign wealth funds in the Gulf are widely thought to be diversifying at the margin. In 2006, Rachel and I think these funds received roughly $80b from their countries oil surplus, and perhaps invested $40b in US assets. If we are right, the total US holdings of the Gulf's sovereign wealth funds are going up, but not as fast as before.
The Saudis — who do not have a formal sovereign wealth fund — are on track to add about $60b to SAMA's assets in 2007, down from $67b in 2006. Suppose 80% of these flows are in dollars. Their dollar accumulation is down just a bit — but only a bit. Dollar reserve growth should fall from $50b to $48b.
So has the GCC diversified? Not really.
Why — we don't yet know how much the smaller GCC central banks (the central banks of the Emirates, Kuwait and Qatar) added to their reserves in 2007, but a reasonably guess would be between $40 and $50b. The Emirates reserves were way up in the first half of 2007, and that was before EVERYONE started betting on a GCC revaluation. In 2006, the reserves of the smaller central banks only went up by $4-$5b or so.
Almost all these reserves are in dollars, so Rachel and I estimate that dollar reserve growth by the smaller GCC central banks increased from around $4b to around $40b.
Total dollar asset growth — if these numbers are roughly right — increased substantially. It went from $94b to around $118b. The GCC investment funds diversified. But the GCC central banks bought far more dollars. The region's aggregate exposure to the dollar didn't fall — even if the institutions holding dollars shifted.
Diversification from the Gulf's sovereign wealth fund has been offset by faster reserve growth by Gulf central banks.
Bottom line: central banks are almost certainly selling a lot more dollars for euros and pounds (and other currencies) than ever before. That is because they are accumulating more reserves than ever before. But the available evidence suggests — at least to me — that the overall pace of dollar reserve growth has actually picked up substantially in both the Gulf and in China.
And, by implication, the biggest dollar "overweights" in the world economy are still overweight. There willingness to add to their dollar overweight likely has stabilized the market this year — meaning the dollar's fall might have been even bigger. But so long as private demand for US assets remains weak and the US external deficit remains large, any shift in their willingness to support the dollar could have major consequences.
Two observations: while pegging to the dollar (or any other currency, for that matter) certainly does require the pegger to maintain large holdings of the anchor currency in their reserve baskets, by any reasonable measure the BRICs and the Gulf have exceeded that threshold, and did so a long time ago. The US Treasury did a study on this very question, which if memory serves was posted here about 6-9 months ago.
Point two is that from a practical perspective, it is irrelevant whether China, et al are actually diversifying. In the grade scheme of things, does it really matter whether China holds 70% or 68% or 63% dollars? Not really. What really matters is the pace of reserve accrual, and the activities required to maintain reserve benchmarks.
Whether PBOC’s reserve accrual has been $270 bio or $200 bio this year, either way it’s a bloody big number.
Thus, to keep the share of dollars at 70 per cent, which is the level most experts agree on, China would have had to sell more than $3bn per week. This is not impossible, but would have stirred up much more market interest than has been observed.
I don’t know the gentleman who said this, but a comment like this really makes me wonder how he spends his time. If he were to ask his FX trading desk or salesforce, and canvass opinion across similar at other banks, he would find a broad consensus that China runs the show in EUR/USD when they wish to. Frankly, if that isn’t market interest, I’m not sure what is. It is that $3 bio per week that matters- and the amount on top of that from Russia, the Gulf, et al- not the percentage of dollars being held in reserve baskets.
It is likely that China is diversifying into various asset classes across the world, but that doesn’t equate to dumping US Treasury bonds since Central Bank foreign reserves are also increasing rapidly. - Dave C.
China’s Sinosteel Offers $1.1 Billion for Australian Midwest Iron Ore producer
http://www.bloomberg.com/apps/news?pid=20601089&sid=aSyXIMlOroZQ&refer=china
Dec. 7 (Bloomberg) — Sinosteel Corp., China’s second- biggest iron-ore trader, offered $1.1 USD billion to buy Midwest Corp. to secure supplies ahead of a proposed merger of two of the world’s largest producers of the raw material.
“They want to get their hands on iron ore direct,” Gavin Wendt, a senior resource analyst at Fat Prophets Funds Management, said in Sydney. “It isn’t surprising given the extraordinary level of Chinese interest in Australian iron ore.”
Chinese companies have been funding iron ore miners in Australia. China’s third-largest steelmaker, agreed in September to a A$1.8 billion joint venture with Australia’s Gindalbie Metals Ltd. to develop two iron ore projects. Fortescue Metals Group Ltd., building a A$2.7 billion project, has agreed to sell ore to Chinese steelmakers.
Luxembourg ArcelorMittal to pay $1.7 billion for China Oriental Steel Corporation
http://www.bloomberg.com/apps/news?pid=20601089&sid=aJavcASValeI&refer=china
Dec. 7 (Bloomberg) — ArcelorMittal, the world’s largest steelmaker, will offer to pay at least HK$12.9 billion ($1.7 billion) for shares in China Oriental Group Co. it doesn’t own, obeying a regulatory ruling it must bid after a stake purchase.
China Oriental Steel Corporation makes billets and strips, producing more than 3 million tons of crude steel a year. It posted a 769 million yuan ($104 million) profit from sales of 6.65 billion yuan for the six months ended June 2007.
The Chinese steelmaker, which has its main production plants in China’s northern Hebei province and southern Guangdong province, controls closely-held Hebei Jinxi Iron & Steel Co., the nation’s 29th-biggest steelmaker, according to the company Web site.
There’s no BSing the U.S. dollar situation with words. TRILLIONS of debts
Brad, the only word on which I’d disagree with you in your bottom line comment is “willingness” (even taking into account your comment on shifting willingness). Methinks that countries either feel independently obliged to keep adding dollars to reserves in order to maintain the status quo, or that the USA is ‘asking’ them to do so a la Corleone.
Brad, You say “any shift in their (CB’S) willingness to support the dollar could have major consequences.” Isn’t this willingness contingent upon the US maintaining it’s world economic dominance? Can’t a reasonable case be made that this dominance is in decline, and is likely to continue to decline? It seems to me that in terms of power the overweights have benefited from the old economic system and are thus likely to continue to seek to stabilize it, but if reality continues to evolve as it is now won’t it necessarily force a change in the world economic system, and if this change comes later rather than sooner won’t it be more violent?
I fail to see why China does not spend some of its vast dollar reserves on oil to stockpile. You can stockpile oil very easily, can you not? And oil would certainly not be liable to the depreciation that dollars are. Yes, Chinese purchases would send the dollars to the Middle East, so then the problem would be theirs about what to do with them. But at least China would be rid of them and hold oil instead. Anything wrong about my logic?
I should have said “more of its reserves on more oil to stockpile.” I gather China at present intends to store reserves for 120 days consumption. But why not 240 days or 360 days? It would be a better investment that US Treasuries.
Much of what is posted here assumes that China’s accumulation of dollars cannot go on “forever.” But has anyone done any thinking about how much would be “too” much? What if China accumulates 2.5 trillion of dollars? 4 trillion? 6 trillion? Would anything happen in those cases that would stop the accumulation? Perhaps it can go on, if not forever, at least for another five years, or even ten years? What would stop it?
When we use the “all countries” COFER data instead of “industrial countries” data, there’s a different picture that shows up… and it shows a continuing drop in dollar reserves as a percent of total.
http://www.nowandfutures.com/images/cofer_dollars.png
Would you please comment?
Macro Man,
I would be interested to hear exactly what you believe China is doing in USD/EUR? Unless the Chinese authorities cannot trade RMB/EUR, I do not see why they would need to sell USD for EUR. And if they can only buy USD, I would have thought that most of their USD/EUR trades were simply to get them to their reserve currency allocation.
07Dec07 RTRS-RUSSIA SEES 2007 NET CAPITAL INFLOW AT OVER $90 BLN — RUSSIAN AGENCIES QUOTE DEPUTY ECONMIN
07Dec07 RTRS-Russia 2007 capital inflow seen at over $90 bln
MOSCOW, Dec 7 (Reuters) - Russia’s net private capital
inflow is likely to more than double to exceed $90 billion and
hit a record in 2007, Russian news agencies quoted Deputy
Economy Minister Stanislav Kuznetsov as saying on Friday.
“We will exceed a record number of $90 billion this year,”
the agencies quoted Kuznetsov as saying during a visit to
Hungary. “We have already registered (a net capital inflow in
Russia worth) $86 billion,” he said.
The Finance Ministry said last month it expected Russia’s
net private capital inflow to reach $80 billion this year. Last
year’s net private capital inflow stood at $40.9 billion.
“And, by implication, the biggest dollar “overweights” in the world economy are still overweight. There willingness to add to their dollar overweight likely has stabilized the market this year — meaning the dollar’s fall might have been even bigger.”
Sounds accurate, but the flipside of your conclusion of course, is that the dollar’s current value is unsustainable until the current imbalances are addressed. The central banks of China and the GCC are like flood-control workers desperately sticking their fingers in a dam that’s fissuring all over the place. They’re merely postponing the inevitable and, the longer they do that, the more painful the unwinding will be.
The dollar-peg system was a dangerous gamble to begin with since, without any kind of fixed-value reference for the dollar, the currency’s value is maintained *only* by confidence in overall US economic, political and military strength, and *all* of those supports have been grievously undermined by the fiasco in Iraq and the exploding national debt. Moreover, with the baby-boomers on the cusp of retiring, that debt is on the verge of spiraling way upward and essentially becoming permanent– the interest on the debt alone will soon become the biggest item.
IOW, the central banks have all gotten themselves into one very fine mess that they’ll have to be clever to extricate themselves from. I pondered some of China’s exit ramps, for example, in a previous post– http://tinyurl.com/3duvtb (e.g. using a “Yen Bridge,” acquiring big assets in “Dollarite” economies like Ecuador or East Timor and Pesozone economies in Latin America and the Philippines).
But the fact remains that no matter what is done, the GCC and Asian economies are going to have to drag themselves off the dollar peg soon– and the sooner and more sensible they can do it, the better. Right now, the whole situation has the feel of a Ponzi scheme where everyone knows the current system is unsustainable but, fearful of the consequences of re-balancing, they keep feebly trying to postpone it. China’s creeping float does give it somewhat more flexibility than the GCC countries, and so they have more options.
It’s the Gulf countries that I’d really be worrying about. They’re basically one interest rate cut away from some serious hyperinflation there, and the UAE is already witnessing riots and strikes with the inflation they have.
The simplest move IMHO for any country that still does not want to free-float its currency, is to peg against a currency basket rather than the dollar alone. At the outset at least, they’ll still have mostly dollars in there, but they can then “dope” the mixture toward Euros, yen, won, ringgit, probably also the renminbi eventually, and thereby track their currencies according to a much more realistic approximation of global economies and their own trading partners.
The GCC for example, does much more business with the Eurozone than the US, making their own dollar peg even more nonsensical. The UAE IMHO will likely be the first new country to make that move, simply b/c among all the GCC countries, theirs is the one that has diversified most away from oil, and their levels of inflation as it is are threatening some severe social unrest to the point of eventually threatening the Emirates’ survival itself. They absolutely must drop the peg and, the longer they defer this move, the more they flirt with disaster. It’s a fairly conservative move to migrate toward a basket. Moreover, I doubt it’ll even lead to a dollar crash. Mainly, it’ll help to engender a revaluation and a more balanced relationship with world economies.
Off topic:
Asset-Backed Commercial Paper Yields Increase Most on Record
By Bryan Keogh
Dec. 7 (Bloomberg) — Yields on commercial paper backed by assets such as credit cards and mortgages rose at the fastest pace in at least a decade as investors retreated from buying debt that may contain subprime mortgage assets.
Yields on 30-day asset-backed commercial paper rose 91 basis points to 6.06 percent this week, or 82 basis points more than the one-month London interbank offered rate, the largest gap on record, according to data compiled by Bloomberg.
The increase “shows a severe condition,” Tony Crescenzi, chief bond market strategist in New York at Miller Tabak & Co., wrote in an e-mail message to clients today.
The rising yields come as banks and other companies seek buyers for the debt to buttress their cash before the end of the year. The surge may prompt the Federal Reserve to be more aggressive in cutting its target interest rate next week to help reduce the cost of borrowing, Crescenzi said.
Dollar reserves are, I imagine, seen as convertable to oil/oil futures, more than anything else. If China can use their kitty for anything better, I don’t see it. But, doesn’t that imply that when Chinese held tresury bills become due they will very likely be payable to the oil exporters, rather than China?
RE, PBOC accrues the vast, vast, vast majority of its reserves in USD. And yes, they sell a portion of those dollars/buy euros and other stuff to meet reserve benchmarks. It is absolutely indisputable that they do this; hence my surprise that the “JPM head of central banks” did not seem to know about it. Tellingly, the people I know in the JPM foreign exchange department, where this flow would be executed, have never heard of this chap.
While $3 bio a week may seem like small beer in the foreign exchange market, as a net total it is actually a very susbtantial amount that has a huge market impact. It is a source of great bemusement amongst practioners that this is not universally recognized.
I note that neither Brad not anyone else is prepared to outline what might happen if Chinese dollar reserves were to hit 2.5 trillion or more. Is this too impossible to imagine? And if so, why?
Guest — give me a bit of time. Sometimes other obligations prevent an immediate response. $2.5t is not all hard to imagine. By the end of q4, China would have — counting the CIC and reserves shifted to state banks via swaps and the like — something like $1.7 to 1.8t in reserves. Those are currently growing at $500b a year. I would not expect that to change next year — indeed, china will be lucky to only add $500b if it doesn’t get its act together. That means China should hit 2.5t sometime in 2009. I fully expect China’s reserves to rise about $3t in a orderly exit from bretton woods 2. The key constraints here are the capacity to continue to use the banks as a sterilization tool, and China writ large’s continued willingness to add to its future losses from a massive losing bet on the dollar and the euro v the rmb.
bart — i don’t recognize the graph that you posted. my guess is that the source of the graph took total dollar reserves as reported by COFER and compared that to the overall total. that is incorrect. the right way to do the calculation is to compare total dollar reserves with the total for all countries who report data to the imf.
basically, the reserves of the countries who do report their currency composition is rising quite fast, and the imf doesn’t estimate the currency composition of the guys who do not report — to my immense benefit, since it gives me a nice little business. as a result, reported $ reserves is sliding as a share of total reserves, but largely b/c reported reserves of all kind are sliding v the total.
nice comments today; sorry i couldn’t be more active in real time.
macro man — great comments.
I am not a practioner (or at best an amateur practioner) but my intuition has always matched that of the practioners.
I have to say though that here there is a very real divide between the academics and most G-7 central bankers and the market practioners. The academics tend to think the fx market is perfectly efficient (in the economic sense) and fully reflects all available information about future economic performance and other “fundamentals” so any one off flow would generate an offsetting counter-flow, with minimal impact on price. If china wants more euros, private investors would buy more dollars the moment chinese demand moved the euro away from its “Right” price. That after all is why the conventional wisdom among g-7 central bankers (japan aside, but there is a debate even in japan) is that intervention almost never works, b/c it doesn’t change the real fundamentals. If the fed buying euros has no impact, the logic goes, why should China buying euros have an impact.
The academics/ central bankers would also tend to argue that $3b a week/ $12b a month is small beer in the vast/ huge/ enormous fx market with trillions of turnover, so the flow just seems large.
I would say most practioners have a slightly different view — one closer to your view. They care a lot more about the flow.
And in my view, rightly so — I don’t think there is enough private demand for US $ assets to make up for a the loss of the roughly $500b in combined GCC/ Chinese purchases this year. If that source of $ accumulation goes away, well, something has to give. But here I would say that I am in the minority when I speak in more “official” settings.
Your point that it doesn’t really matter whether CBs are reducing the dollar share so much as selling dollars is a good one — I think that explains why folks in the market tend to think there is a lot more diversification going on that I do. I define diversification as reducing the $ share of your reserves (Russia, early 2006 = clear example). Market folks tend to define it as sale of dollars, whether to meet an existing portfolio benchmark or to meet a new (higher) portfolio benchmark for euros/ pounds. And this year — given the increased scale of reserve growth — there clearly has been more $ sales even if there hasn’t been much diversification.
Russia is an interesting example: by virtue of having diversified in 2006 (in the sense of reducing the $ share of their reserve portfolio), they were in a position where they had to sell a lot of $ to buy euros and pounds to meet their benchmarks when capital inflows into russia picked up and russian reserve growth accelerated. no further diversification, but a lot larger $ sales.
And I’ll see if I can convince my former Treasury colleagues that the euro/ $ is now also set by the PBoC, not just the RMB/ $ …
Macro Man and Brad,
Thanks for your answer Macro Man…..what I thought. If that is really how it works, China’s involvement in USD/EUR is simply a leg of its intervention, and should not be thought of as strengthening the EUR against the dollar, because they already bought the dollars in against renminbi in the first leg, and the dollars involved cancel out. I agree with Brad that a “going away” $3bn matters, but it is $3bn worth of RMB/EUR not $3bn of USD/EUR. Whether Chinese intervention stregthens the EUR vs the USD depends on whether the supply of USD is so much more elastic than that of EUR that the smaller amount of EUR that China buys moves its value more than the larger amount of USD moves the USD. I cannot be sure of the answer, but my guess would be that the larger amount of dollars wins, and that Chinese intervention actually strengthens the dollar versus the euro. My interpretation of the strength of the euro against the dollar is that the ECB had retained enough of the Bundesbank credibility for the EUR to be seen as a safer store of value. There has always been some doubt about that however, and last week, with lame excuses being made by the ECB for not tightening, in my view for fear of driving southern Europe and Ireland into the ditch, strengthened that doubt further, hence EUR/USD retreated from 1.50.
RE, I don’t think it’s as simple saying “the dollars cancel out.” The missing part of the equation is what would have happened to the original dollars had they not been sold for RMB to begin with. In other words, if economic actors had not been buying RMB, would they have been buying euros instead?
If 30 cents of every dollar sold for RMB would have otherwise gone into euros, then I would agree it should not have an impact. However, I don’t think that is a correct assumption. Would 30% of the FDI capital directed to China been allocated to the Eurozone if China did not allow the investment? I tend to think not- it would have gone to some other, cheaper area.
From a speculative point of view, to bet on RMB appreciation more or less requires that one go short USD, given that USD/RMB is the liquid tradeable currency rate. I’d submit that if all currency speculation on RMB ceased, you would actually see a reduction in the supply of dollars from speculative short sellers, which would lead to a broader dollar rally. I don’t think many specs selling USD/RMB would choose to sell USD/EUR as an alternative.
Trade is something that is probably too complicated to make braod assumptions on , but my sense would be that Europe would not fill 30% of the global gap if China decided to quit exporting; other Asians and, frankly, the US would do the bulk of the replacement.
So in sum, I would say that less than 30% of the dollars that are sold for RMB would have been parked in euros as an alternative if RMB buying were unavailable; as a result, China’s sales of 30% of its dollar buys (and purchases of euros) DOES have a net impact.
All of this leaves aside, of course, the second order effect of how China’s market activities impaqct the private sector. Nothing could illustrate the wedge between academia and practioners more than the example cited by Brad above. Faced with a large, quasi-price insensitive buyer, academics would appear to suggest that the private sector would immediately take the other side. In the real world, quite the contrary happens; if a trader knows that China is buying euros at, say, 1.4625 €/€ (and that the Middle East and Russia are bidding there too), he will buy euros himself on the expectation that all these sovereign types will eventually pay a higher rate, especially as their stock of FX reserves continues to grow.
In practice, that’s pretty much what has happened in the fourth quarter of just about every year since 2002.
Macroman –
Academics do more than appear to suggest that traders would take the other side; the models in effect assume that traders will take the other side … that is the mechanism that generates the strong conclusion that sterilized intervention (and chinese sale of dollars for euros can be modeled as sterilized intervention as it has no impact on the us or european money supply) has no impact on the exchange rate/ price of bonds.
Macro Man,
Interesting. You seem to be arguing that the supply of euros for renminbi faced by the Chinese authorities is indeed inelastic - ie that it is tougher for the Chinese to get euros for renminbi than dollars for renminbi, because some of the dollars would have been sold for renminbi substitutes anyway. I think…..
I would suggest that any speculator who made money expecting EUR to appreciate against the dollar because he heard of PBoC buying for dollars is lucky. If PBoC had been doing the two legs I identified in reverse order, their next trade would be a dollar purchase, which should be bad for an EUR/USD long.
RE, I look at it another way: if EUR/RMB were the primary mechanism of Chinese CB intervention, and SAFE then sold some of those euros into the market in exchange for dollars, I would agree that it would mean EUR/USD goes down.
Brad, by that definition, then, ANY large flow could be classified as sterlilized intervention and thus have no market impact. Followed logically, that would imply that if everyone in the world decided to convert their local currency holdings into euros, the exchange rate value of the euro wouldn’t move…..because then everyone in the world would simultaneously decide to take the other side of the trade?
“…The manager with the state-controlled VTB 24 bank oversaw lending operations to companies involved with Russia’s lucrative logging industry…” http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article3019237.ece
“…the Russian Far East Regional Department for Fighting Organized Crime (RUBOP)… has already obtained a good portion of data and documents demonstrating that the timber business is controlled by Chinese mafia groups… there are many untapped resources in the Russian Far East, and potential to make a high profit…” http://www.forest.ru/eng/publications/wildeast/02.htm
Macro Man,
You are still not quite clear. What does “it” mean? Of course I agree that if the Chinese sell euros for dollars, this should depreciate the euro against the dollar (actually EUR per USD would go up not down, but I think I know what you mean!). But if by “it”, you mean the whole caboodle, including the initial purchase of euros for renminbi, then I am not sure that we do agree. I would have thought that, assuming that the subsequent (eg reserve diversifying) purchase of dollars is minor, the overall effect in this case would be to strengthen the euro against the dollar, because the primary target would be to weaken the renminbi against the euro.
Discussing currencies, especially outside the fx market, is always confusing. Better not to say “up” or “down”, and to say “USD per EUR”, not “eurodollar”.
Macroman — I agree with you. There is something strange about the argument that big private flows matter (in part b/c they convey information) but big public flows don’t …
But I assure you the intellectual currents among most g-7 central banks still swirl most strongly around the notion that intervention doesn’t work — and the central bank/ treasury shouldn’t be active in the fx market.
conversely, EM central banks/ wealth funds are now busy becoming the dominant players in part of the market.
Wes: “The central banks of China and the GCC are like flood-control workers desperately sticking their fingers in a dam that’s fissuring all over the place. They’re merely postponing the inevitable and, the longer they do that, the more painful the unwinding will be.”
I don’t see any desperation and inevitability in China’s policy. I think what they are doing is the winning strategy. The amassing of trillions of dollars is a way of buying growth and economic power. Are growth and economic power worth a few trillion of seemingly useless dollars? I think they are. And as a by-product they leave the trillions of dollars to their grandchildren, who may be able to spend them on american goods and services in the future.
By the way, I agree with both of you (MM and Brad) that sterilised intervention should be effective (albeit less so than unsterilised intervention of course). And as Brad astutely noted last week, the fact that some of these G7 central banks justify their own lack of preparedness to intervene by saying that intervention is ineffective does not stop them complaining about what China does. In my opinion, one reason for this is that such central banks tend to be run by people from a limited circle who are not called to account by shareholders or electors.
So can any of you tell me when we will be forced to switch over to the Amero or a global currency? I don’t pretend to know much about economics but I don’t see how all this money can keep changing hands globally without turning into an ever bigger mess. It seems from what I’ve read above that no one has any real handle on it anyway, assuming any good percentage of the posters here have any real idea what they’re writing about. Oh, and if someone could tell me what stock to buy that’d be great as well.
thanks.
“basically, the reserves of the countries who do report their currency composition is rising quite fast, and the imf doesn’t estimate the currency composition of the guys who do not report — to my immense benefit, since it gives me a nice little business. as a result, reported $ reserves is sliding as a share of total reserves, but largely b/c reported reserves of all kind are sliding v the total.”
Thanks Brad, now I understand what your chart is showing and why it differs. More power to “IMF data gaps” and a nice little business.