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Central banks still (heart) dollar reserves

by Brad Setser
May 22, 2009

Though perhaps not long-term Treasuries.

There has been a lot of talk about the dollar. And about the shift in China’s rhetoric; China no longer seems all that happy to continue to add to its already considerable dollar reserves. But, well, there isn’t much — I would even say not any — evidence that central banks have really lost their appetite for dollar reserves. The rise in foreign central banks’ custodial holdings at the Fed over the last 13 weeks has been rather impressive.

It is back at peak or near peak levels.

fed-custodial-holdings-may-20-1

In the first three weeks of May central banks added over $60 billion to their holdings at the Fed. That is way more than the US needs to finance a $30 billion or so monthly trade deficit.

The rise in custodial holdings of Treasuries might reflect an ongoing shift out of bank deposits and money market funds. But that doesn’t quite feel right anymore. A host of central banks — Korea, Russia and possibly Brazil, just to name the most obvious suspects — are once again intervening in the market to limit their currencies rise.

The rise in Treasury holdings clearly no longer reflects a shift out of Agencies. Custodial holdings of Agencies have been flat recently.

frbny-may-21-2.PNG

If I had to guess, I would bet that cental bank reserve growth has resumed. A dollar sell-off against the big “floating” currencies generally has been correlated with more intervention among those emerging market central banks that manage their currencies against the dollar.

Clearly, though, something has changed.

And I suspect the main change is that almost all the dollars that central banks are buying are getting channeled into shorter-term Treasury bills, not longer-term notes. That is quite different than in the past. In 2003 and 2004 — and again in 2007 and early 2008 — a spike in central bank intervention would lead to a rise in central bank demand for longer-term bonds.

As the yields on longer-term Treasuries rise, though, the opportunity cost — or at least the foregone interest income — of staying in bills rises … at some point, I would guess that some reserve managers will need a bit of income, and become convinced that yields on longer-dated Treasuries have risen by as much as they are going to rise.

32 Comments

  • Posted by WStroupe

    Brad said, “Clearly, though, something has changed.”

    Two possible factors?

    One, CBs want higher liquidity afforded by short-dated Treasuries so they can sprint elsewhere if/when needed.

    Two, they are leveraging Washington’s QE for all its worth, playing a game of chicken with the Fed and domestic U.S. savers and making them (instead of the CBs) step up to buy longer-dated Treasuries to keep yields from rising and eroding the CBs holdings.

    I think the CBs win the game of chicken because the Fed’s leverage is less than theirs. And when the Fed buys the longer-dated Treasuries, guess who’s going to be selling??? The CBs?

  • Posted by Scott Peterson

    It reads to me like you are telling us that the foreign CB’s are printing their currency to sell and invest in US debt; in order to prop up their export sectors. These countries need to focus on developing domestic demand instead of fighting over exports to the USA.

  • Posted by Dennis Redmond

    Yep, oil is back up over $60, mostly because the BRICs were smart enough to put a floor under commodity prices, and the core economies have started to fix their banking systems (it’s going to take time, but they’re moving in the right direction). Looks like the world-economy is starting to stabilize. We’re not out of the (Bretton) woods yet — Europe needs to start spending more, to give the East Asian economies time to boost consumption. But things have stopped getting worse, which is a good thing. In the long run, I think we should acknowledge that 2 billion new consumers in the BRICs want and deserve a better standard of living, and we have to figure out a way to let that happen.

  • Posted by don

    Competitive devaluations, ala GD1. It should be stopped. The argument that the U.S. ‘needs’ the foreign loans to fund its trade deficit should now be recognized as fully defunct, helped along in its demise by Krugman’s recent statements (since no one seemed to want to take my word for it).

  • Posted by bsetser

    dennis — in at least some BRICs, the obstacle to a better standard of living is their own government’s determination to keep their countries currency down to encourage production at the expense of better short-term living standards. remember, so long as the RMB is pegged to the dollar, a dollar depreciation is an RMB appreciation — so the RMB had a bad week this week …

    the way to let that happen is for emerging economy governments to wean their economies off export based growth; in china’s case, the obvious shift is from a policy mix of a weak XR and tight fiscal to a stronger XR and looser fiscal.

    Scott — good point. but it also important to differentiate across countries. russia spent a ton of reserves and you can see why it might want to buy some back now that market conditions have improved. brazil has let its currency rise back to 2 in a fairly short period of time, etc. i agree with your general point, but the market for EM debt/ currencies turned really quickly and some countries have experienced a big appreciation in a fairly short time (tho generally after an even bigger depreciation last fall)

  • Posted by Cedric Regula

    I posted this in the previous thread before I noticed the new thread. But it probably fits here even better, so I’ll re-post.

    Long end of the treasury market got hammered again today. I had a one handbagger day.

    Dollar Index looked like it would go down another 1%, but closed down only a half.

    If the buck keeps dropping at this rate, the Dollar/RMB might trade at parity in about 65 days.

    http://quotes.ino.com/chart/?s=NYBOT_DX

    Next week the Treasury sales goal is $101B in the 2-7 year range. That’s why the drop this week, but will it continue next week?

    Odd things the past few days: Both Japan and Britain got downgraded from AAA. Both currencies increased against the buck!?

  • Posted by John McLeod

    Just from the “sports reporter” perspective, over the last two weeks those custodial holdings of treasuries rose $50.9 billion, which is nearly unprecedented (the biggest 2-week moves ever were October 1, 2008 combined with the week before or after — cenbanks were fleeing agencies then).

    Seems funny to be seeing such exuberant buying at a time when so many are questioning treasuries as an investment.

  • Posted by Tono

    The shortening of the maturity distributions for countries in general is a well-known fact, and one that has been often mentioned by bsetser. Now that the game of musical chairs of funding long-term assets with short-term debt has been taken to a sovereign level, countries are doing the rational thing and staying away from the long-end of the reserve currency economies’ debt.

    It is no coincidence that QE has been undertaken in three of the four reserve currencies. I believe the EU cannot be that far behind, but perhaps I don’t understand the structural differences in their bond markets.

    On my blog, I have been tracking on a weekly basis how each of the Fed’s QE programs is doing (Treasury, Agency and MBS) on a cumulative basis. I have also overlaid the 30Y yields and the USD index in order to gauge the hidden costs of QE since this is where you would expect the costs to show up first. Indeed they have, and quite dramatically. This will continue as QE is ramped up.

    http://www.debtorsprisonblog.org/journal/2009/5/21/weekly-fedbs-qe-update-052109.html

  • Posted by jonathan

    There are other possibilities, mostly rooted in fear and a prudent reaction to worry. What if the markets tighten again? Better have short-term dollars because you’ll need them. What if the world economy gets worse – or stays at a lousy level with little sign of budging up? You’d see issues with your currency’s value, issues with trust of counter-parties (including sovereign debt), issues with funding your own credit institutions. Better have short-term dollars just in case.

    BTW, is this level of purchases really enough to support the dollar and thus manage your currency against it? This is not my area of interest or expertise.

  • Posted by DJC

    US Dollar Hegemony is gradually being eroded, but it will still be a decade or longer before it is replaced. The petro-dollar remains backed by US military projection power across the Gulf Arab Oil States. Everyone needs the US Dollar because oil is only sold in US Dollar currency. Those Gulf Arab dollars are recycled through New York money center banks including Citicorp and the Federal Reserve. The Iraqi government is required to hold its oil export wealth on escrow at the New York Federal Reserve. Essentially, from the fiat printed US reserve currency, the Gulf Arab states provide their oil to the US for paper. The Chinese and the rest of the world under US Dollar hegemony get to work for free, and Americans get to consume for free.

    http://en.wikipedia.org/wiki/Dollar_hegemony

    The term describes a geopolitical phenomenon of the 1990s in which the U.S. dollar, a fiat currency, became the primary reserve currency internationally. Three developments allowed dollar hegemony to emerge over a span of two decades.

    Thus “dollar hegemony” prevents the exporting nations from spending domestically the dollars they earn from the U.S. trade deficit and forces them to finance the U.S. capital account surplus, thus shipping real wealth to the U.S. in exchange for the privilege of financing U.S. debt to further develop the U.S. economy.

  • Posted by DJC

    PetroDollar Warfare

    http://en.wikipedia.org/wiki/Petrodollar_warfare

    The phrase petrodollar warfare refers to United States foreign policy over recent decades that has been the status of the United States dollar as the world’s dominant reserve currency and as the currency in which oil is priced. The term was coined by William R. Clark, who has written a book with the same title. The phrase oil currency wars is sometimes used with the same meaning.

    The value of the U.S. dollar is determined by the fact that many key commodities (particularly oil and natural gas) are denominated in dollars. If the denomination changes to another currency, such as the euro, many countries would sell dollars and cause the banks to shift their reserves because they would no longer need dollars to buy oil and gas. This would weaken the dollar relative to the euro (see supply and demand).

    The core of the US foreign policy is that U.S. administrations are greatly motivated by fear of the consequences of a weaker dollar, particularly higher oil prices. This motivation is seen as underlying and explaining many aspects of U.S. foreign policy, including the ongoing Iraq War.

    Most oil sales throughout the world are denominated in United States dollars (USD). Because most countries rely on oil imports, they are forced to maintain large stockpiles of dollars in order to continue imports. This causes demand for USDs to remain high, regardless of economic conditions in the United States. This in turn allows the US government to gain revenues through seignorage and by issuing bonds at lower interest rates than they otherwise would be able to. As a result the U.S. government can run higher budget deficits at a more sustainable level than can most other countries.

  • Posted by bsetser

    DJC — the dollar hegemony because oil is priced in dollars argument is a bit old.

    a more interesting argument is that the GCC’s inability to agree among itself on the location of a central bank (they choose Riyahd, but then the UAE withdrew from the project) means that the Gulf will by default continue to peg to the dollar … at some cost to itself given differences in the macro position of an oil exporter and an oil importer … and in the process continue to need to build up dollar reserves. Saudi Arabia’s apparent willingness to keep a large share of its reserves in dollars also matters …

    tho the saudis aren’t the ones driving the recent rise in the custodial accounts. their reserves fell by almost $25b in q1, and for seasonal reasons they tend not to add many reserves to their stockpile in q2 (and even at $60 oil they won’t have a big surplus given their production cuts).

  • Posted by FollowTheMoney

    Mallaby has it right, there’s a war over exchange rates…which is a sort of protectionism in the sense that countries in today’s society are protecting respective exports. This mistake of devaluing currencies so that one country can export more than another in today’s globalized world will indeed play out to be a major mistake. Currency devaluations will inevitably lead to a global currency crisis over the next 1-2 years.

    @ dennis rodman “But things have stopped getting worse, which is a good thing”

    By the end of 2009, in my opinion:

    -We’re looking at UE rate of 14% (U.S.)

    -European banking crisis involving large failures due to loans to eastern europe which have gone bust.

    -Major pullback in U.S. consumer credit and consumer consumption. Larger than expected job cuts and many many many more retail and commercial bankruptcies.

    -Geopolitical tension. Pay attention to the MIDDLE EAST in the Fall…

    As a matter of fact, on this May 23 of 2009 there is greater uncertainty over the outlook than ever. When the world does return to the growth it will be SLOW and PROTRACTED.

    Finally, the crisis will not be over until a solution to the United States 20 Trillion of excess debt has been looked at, the next stage of the crisis involving treasuries/currencies will be WORSE than the stage involving Financial Institutions.

    In my opinion, over the next 12-18 months the world will witness the unexpected.

    Be Prepared, things my friend could move quickly!

  • Posted by jonathan

    DJC, you actually posted a wikipedia article?!? Seriously, dude.

  • Posted by WStroupe

    FollowTheMoney said, “Mallaby has it right, there’s a war over exchange rates…which is a sort of protectionism in the sense that countries in today’s society are protecting respective exports. This mistake of devaluing currencies so that one country can export more than another in today’s globalized world will indeed play out to be a major mistake. Currency devaluations will inevitably lead to a global currency crisis over the next 1-2 years.”

    Compelling argument. The new protectionism, which leads almost inevitably to a deeper crisis – that of multiple currencies. But could you/others talk a bit more about how this potentially unfolds and which currencies are at the most risk, those of the developed nations of the West or those of the emerging economies? In other words, who’s most likely to win the war of exchange rates, and why? I think this issue may be either at the heart of matters, or very close to it, as respects how this crisis plays out from here forward.

  • Posted by Dennis Redmond

    Brad Setser wrote:

    > the way to let that happen is for emerging
    > economy governments to wean their
    > economies off export based growth; in
    > china’s case, the obvious shift is from
    > a policy mix of a weak XR and tight
    > fiscal to a stronger XR and looser
    > fiscal.

    Very true. What makes me more hopeful than last fall, when things were really falling apart, is that both are starting to happen — Brazil and Russia have FX rebounds, and both Russia and China have launched huge stimulus packages. The Congress victory in India signals some level of fiscal expansion in South Asia, too. I don’t track Brazil closely, so if other posters know what’s going on there, let the rest of us know.

  • Posted by chaingangcharlie

    @DJC -
    Dollar Hegemony Dept of Naive Questions ( if you don’t mind ) :
    Let’s say I am an Oil Sheik ( bear with me -
    Sheik Ibn-al-Raschid- al- Charlie.)
    I sell oil for a few million USD.
    What are my options re those dollars ? Can I not just trade them for ( i dunno..) Latvian Escudos or whatever ? ( I told you it was naive time).
    I recall Kissinger twisted arms to get this ‘dollar only’ Saudi oil deal, so it sounds as if there must be *something* of some magnitude in it for U.S… but then Brad says the whole idea is just ‘old’ ( but then ‘old’ can also be ‘true’ no ? ) .
    And I don’t see anything particularly vile about quoting Wiki.
    Another symptom of naivity ?

  • Posted by WStroupe

    Brad said, “DJC — the dollar hegemony because oil is priced in dollars argument is a bit old.”

    Nevertheless, there certainly is a connection between dollar hegemony and the fact that oil is priced in dollars. If key exporters of oil (say, like Russia and/or Saudi Arabia) were to ‘breach the dike’ by pricing oil in something other than dollars and settling oil trx in something other than dollars then the dollar’s “reign” as the primary international reserve currency would be seriously damaged. Other exporters would likely follow suit, and exporters of other commodities would also be tempted to follow suit.

    Make no mistake about it, though, getting the dollar out of international spot markets and pricing of commodities is no small task – it would be very complicated and ordinarily very time-consuming to accomplish. And what currency would replace it? There you have a gargantuan fight amongst those who would like to put their particular currency forward. It would be a real mess. Unless some sort of real dollar crisis forces the international players to address this in real earnest, and maybe something like the synthetic SDR could replace the dollar in all spot markets / pricing mechanisms – I don’t know.

    But the fact that the dollar is used as the pricing standard and settlement currency for 200 bazillion products worldwide certainly enforces the dollar’s position internationally. Players are usually averse to chaos. Dumping the dollar spells chaos. Therefore, its position is reinforced internationally. Unless, as I said before, a sufficiently severe crisis in the dollar itself absolutely forces the players to replace it with something else. Could happen – I wouldn’t want to just dismiss this possibility out of hand.

    In the aftermath of the 1973/74 Arab oil embargo the U.S. came up with a truly ingenious solution to the inherent weaknesses (from the U.S. point of view) of that old oil and monetary order. The old oil order at that time was characterized by the bilateral long-term supply contract between suppliers and importers. It was very susceptible to supply issues (problems) because the inordinate role of the bilateral long-term supply contract severely limited the system’s ability to quickly cover a supply problem that showed up somewhere in the system. It was very rigid, grossly lacking “liquidity” of supply, or fungibility. So, you could embargo someone, because it was rather difficult, time-consuming and expensive for the target of an embargo to cover himself with supply from somewhere else in the system. The solution?

    Ingenious! Set up spot markets, denominated in dollars, and sell “paper oil” (oil futures contracts) on those spot markets. The new spot market and futures contracts created a new order characterized by very high supply liquidity, of fungibility, for oil. In a virtual sense, this new order created one global pool of oil, denominated in dollars, into which almost all suppliers place their oil and out of which virtually all importers buy their oil. In such a virtual pool, a supply issue almost anywhere in the system is quickly, easily and naturally covered by supply from somewhere else. In a literal pool, say a big dish, try taking oil out at a certain location of the dish and keeping that location free of oil – you can’t because oil rushes in from everywhere else around the dish to fix the problem location. That’s virtually how the new oil order created by the U.S. and Britain works too. A fundamental component of that new order was the key role of the dollar in all those spot markets. The U.S. got the Arabs to accept the new order, and it fed upon itself to massively reinforce the dollar’s international role, in all commodities, not just oil, and in most everything else too. This explains why the U.S. gets just a little bit testy when you start talking about selling and pricing oil in something other than dollars.

    That ingenious new oil/monetary/market order really does what it was supposed to do – it prevents an embargo as long as the world adheres to it. I’d like to shake the hands of the geniuses who conceived this solution – it’s truly remarkable! However, it does have vulnerabilities, and we’ll have to see if very clever powers exploit these in future.

    But the so-called “old” argument that ties together dollar hegemony and the pricing of oil (and so much other stuff) in dollars is not to be discredited, as long as it’s seen in its proper perspective, as I’ve tried to explain as concisely as I can above.

  • Posted by chaingangcharlie

    WStroupe :

    I don’t know if your reply above was meant for me but it went to my questions , for which thanks.
    But – going back to one missed point – ok I need dollars to buy oil => big demand for dollars.
    But then, if I, as an oil sheik , don’t happen to like dollars today, I can sell my unwanted dollars for dinars or whatever => big lack of demand for dollars.
    Net, I don’t see that the dollar /oil thing *neccessarily* gives the dollar any great advantage over the dinar, except the ( trivial ?) trouble involved in 2 X currency exchanges if you want to stay out of dollars except at the ‘point of sale’.
    Am i missing something ? Are petro-dollars all marked “not to be sold for any other currency & only to be invested in US assets” ?
    Being English, I’d kind of like to believe ‘Dollar hegemony’ was some Global Domination Strategy dreamed up by the US military/industrial cabal but ( as of now at least ) it just doesn’t seem to work.

    I *do* see ( i think) that there must be untold trillions of US dollars floating around the world ( as reserves ) that would presumably kill the dollar if they were ever sent back home with their tail between their legs.

    Any enlightenment appreciated.

  • Posted by WStroupe

    chaingangcharlie asked, “Am i missing something ? Are petro-dollars all marked “not to be sold for any other currency & only to be invested in US assets” ?”

    It’s a little more complicated when you consider that the oil Sheiks’ currencies are pegged to the dollar. Now, you have to ‘buy and hold’ dollars (thus accumulating reserves) in order to keep your own currency pegged to the dollar.

    Also, as far as financial assets are concerned, Treasuries and the dollar have a pretty good track record as compared to any other financial asset. So, there’s little choice of what to keep your reserves denominated in. But going forward, this could all change as the dollar is debased by Washington’s policies. That’s the rub – so far, Central Banks still (heart) the dollar, but as Brad points out, not ‘to have and to hold until death us do part’, but more and more its short-term only, because increasingly, these people are genuinely afraid of what happens when the U.S. tries to exit QE and its other dollar-debasing policies.

    Will the oil sheiks destroy their currency pegs to the dollar anytime soon? Depends on how the dollar’s health goes, and on how much Asia and the other emerging markets take over trade precedence, thus reducing the sheiks’ reliance on the U.S. market, and of course on how well the U.S. economy recovers, and how soon it does so. Also, if an Israeli strike on Iran happens and the entire security arrangement in the Persian Gulf maybe gets thrown in the ashcan, and the sheiks end their excessive security reliance upon the U.S. and look Eastward, then the dollar loses a lot of importance to them.

  • Posted by DJC

    The US export market is toast, the US consumer balance sheet will take a decade or longer to repair. China and Japan will have to reinvest in their domestic markets: some to fruitful results (China) but others to no avail (Japan). Whatever they do, it is clear what they will NOT do – that is, they will not buy unlimited US sovereign and state-guaranteed debt. The China PBoC is gradually diversifying to other asset classes including Euro bonds, equity investments around the world, oil reserves, natural resource holdings, and even Gold.

  • Posted by bsetser

    DJC — you left out that the pboc also has been shifting out of private us debt into us treasuries … and that its portfolio equity purchases are way way down.

    i am curious who you think accounts for the $130b or so rise in central banks holdings of treasuries at the fed if not, at least in part, China?

    i am pretty sure it isn’t the Saudis.

  • Posted by chaingangcharlie

    WStroupe said:

    “It’s a little more complicated when you consider that the oil Sheiks’ currencies are pegged to the dollar. Now, you have to ‘buy and hold’ dollars (thus accumulating reserves) in order to keep your own currency pegged to the dollar.”

    OK , thanks, I’m getting there. So the whole ‘petro-dollar as great advantage to US” has only worked so long as the sheiks peg to the dollar, by accumulating dollars. But then , I have never heard Geithner ( or Brad) complaining about *Saudi* ‘currency manipulation’. ( As opposed to Chinese ditto).
    Is dollar accumulation / pegged currency therefore ‘good’ so long as it happens to be in US interest, and de facto ‘bad’ as soon as it isn’t ?

    below is from
    http://www.marketoracle.co.uk/Article10605.html
    ( first that came to hand) =>

    ==============

    It was a Kissinger – Saudi royal family scheme to revive dollar dominance by recycling petrodollars into US investments and weapons in return for guaranteeing the kingdom’s safety – mainly from America had they turned us down. [ my note : LOL ] In a word, it was protection money like the underworld extracts on a smaller scale with oil now backing dollars instead of gold. Henceforth, countries need dollars to buy it and require exports for enough of them.

    As for oil producers, Wall Street and London bankers profited from windfall petrodollar deposits – recyclable as developing nation loans to buy oil but at the same time to be entrapped in permanent debt bondage. Pre-1973, Third World debt “was manageable and contained….financed mainly through public agencies (for projects) promising solid economic success.” That changed when commercial banks took over. Their business isn’t development. It’s “loan brokering (or) loan sharking,” preferably with dictator/strongmen able to cut deals on their own.

    Later the IMF got involved. At the behest of giant bankers, as “debt policemen” instituting rigorous structural adjustments, including slashed wages and social benefits as well as state asset sales on favorable terms to private investors.

    At the same time, America got deeply indebted. It’s now the world’s largest by far and needs hundreds of billions annually to keep the dollar recycling game going – in the last 12 months alone, far more than that after the national debt doubled. Today, the nation is “hopelessly mired in debt to support the banking system of a private international cartel.” Ordinary people pay the price.( end quote)
    ==========

    So, was it “a Kissinger – Saudi royal family scheme to revive dollar dominance by recycling petrodollars into US investments and weapons ” ? Was it a case of “we keep you guys ( Saud family) in power, but then you play by our rules ” ?
    ( BTW Weren’t the 9/11 hijackers Saudi ? At this point, I start to see conspiracies everywhere…)

    Makes you wonder if the ideal solution in current circumstances would be for US to sell arms to the Chinese . (Big time)
    I hear they are in the market for a few aircraft carriers :-)

  • Posted by Rien Huizer

    Brad,

    Too many conflicting signals at present. But China’s preference for tbills makes sense, as long as there is enough of the stuff (and there will be until the crisis is over).

    A declining dollar and rising CB USD holdings are a bit confusing, but perhaps leads/lags etc. Japan must be very unhappy vis a vis China and Korea.

    Areas for concern: GBP and EUR member Ireland. Eastern european EU members on the threshold of EUR and sandwiched between contries east of the border with depreciating currencies and countries west with deliberate deflation (like Germany). What is next?

  • Posted by WStroupe

    chaingangcharlie said, “So, was it “a Kissinger – Saudi royal family scheme to revive dollar dominance by recycling petrodollars into US investments and weapons ” ? Was it a case of “we keep you guys ( Saud family) in power, but then you play by our rules ” ?
    ( BTW Weren’t the 9/11 hijackers Saudi ? At this point, I start to see conspiracies everywhere…)”

    Well, that’s quite a bit of sensationalism, but fundamentally, U.S. and Saudi royal family interests coincided, and a deep and wide-ranging U.S. Saudi alliance was cemented. It came to win the wide support of most of the rest of the oil-rich Sunni Arab regimes and much of the rest of the Western democracies that have high foreign oil dependence. Not many people are saying so at present, but this current financial/economic crisis has the real potential to put such strains upon the de facto alliance that it could conceivably break down – especially on the back of any dollar crisis and/or any military strike on Iran that doesn’t go as expected. We’re entering a very seriously risky period in which the Saudis and other Sunni Arab regimes are getting more and more nervous and even angry at the U.S. in consideration of all the implications of this crisis.

  • Posted by bsetser

    Chaingang Charlie — Tis true that the currency composition of the assets of a country matters far more than the currency used to denominate trade, and for large countries that peg to the dollar, the dollar peg likely creates constraints (not the least a desire not to drive your own currency down) against selling a ton of dollars/ thus encourages dollar accumulation.

    I haven’t necessarily criticized Saudi manipulation as the undervalued SAR wasn’t giving the Saudis a competitive advantage in global markets. But i have consistently argued that the Saudis dollar peg isn’t in their interest — and was an impediment to effective global adjustment. See my 2007 Peterson institute policy brief calling for more exchange rate flexibility in the Gulf/ other oil exporters. I think I have been quite consistent on this — countries with large current account surplus shouldn’t peg their currency to a country with a large deficit, and the economic cycle in the oil exporters isn’t likely to match the economic cycle of the US.

  • Posted by Indian Investor

    There are two solutions to the crisis being worked on: The US Treasury solution is that they have created more than $2 trillion in new credits to the banking system, have assured a $ 700 billion fiscal stimulus and nearly disbursed another $700 billion in bailouts. Apart from this the stock of currency in circulation has been increased by around 9% in a year. Their advice to other countries has been for them to indulge in monetary expansion and fiscal stimuli to an extent that their own currency weakens a lot against the USD. Attaining the US desired ratio of fiscal deficit to GDP also ensures that in future those countries will not have the ability to accumulate forex reserves at the same pace as they did during the boom. In this solution, all countries manage to assuage the effects of the crisis. As confidence returns all countries will have to tighten monetary policies to counter inflationary effects. At the same time, the US Dollar hegemony remains intact. There will be no re balancing in this solution. The US will continue to enjoy the benefits of tributes, such as electronics from millions of Chinese and bug fixes from millions of Indians, etc – for throw away prices in fiat dollars.
    The Xiaochuan proposal on the other hand will effect a systemic re balancing. The SDR will become the reserve currency. For the US, the SDR will be like a foreign currency. it needs to have sufficient reserves in SDR to be solvent from an external financing perspective. Shortfalls would be met by new SDR allocations, that will further level the global distribution of wealth. But this solution will also mean the end of the US status as the primary superpower; the dollar hegemony will be gone for ever. And Americans will be forced to make a living through work other than passing credits around amongst themselves in ever more innvoative ways.

  • Posted by Indian Investor

    The first solution is unacceptable to many countries; specifically Germany refuses to give up the opportunity to be fiscally prudent, maintain a strong EURO and try to replace the dollar as the primary reserve currency. China, obviously, has lost the value accumulated from nerly two decades of exports.Russia, Venezuela, Iran, Brazil, Argentina,… are all openly opposed to this solution. The first solution also mandates that no country should indulge in protectionism, which is also difficult to implement, from a political standpoint.
    The second solution through the Xiaochuan proposals isn’t ok with the US; the US prefers to retain its status as the global hegemonic missile-and-stealth-bomber super-terrorist nation rather than to do some real work, build commerically useful things and sell them to other countries for a profit.
    Since there isn’t any real solution that is uniformaly acceptable, you need to evaluate the facts on the ground and see where things are actually going.

  • Posted by RebelEconomist

    WStroupe: “you have to ‘buy and hold’ dollars (thus accumulating reserves) in order to keep your own currency pegged to the dollar”.

    Actually, I do not think that it is essential for a country to buy and hold dollars to peg to the dollar, as I explain here: http://reservedplace.blogspot.com/2008/07/to-peg-is-not-to-hold.html

    I doubt, however, whether the countries that issue the other major reserve currencies (eg the euro and the yen) would welcome increased reserves inflows either, especially at the moment!

  • Posted by WStroupe

    RebelEconomist said, “Actually, I do not think that it is essential for a country to buy and hold dollars to peg to the dollar”.

    Yet, all those with a peg to the dollar certainly appear to do just that – accumulate and hold dollars. If one or two or a few of the more minor players with a peg to the dollar refused to do so, It might not necessarily make much of a difference, I suppose. But when you’re pegging your currency to the dollar you don’t want the dollar to weaken too far, too fast, for obvious reasons. So buying up and holding the dollars to keep your currency pegged results in keeping the dollar afloat via sustained demand for it, and this tends to keep it from weakening too far too fast. But if private investors start to sour on the dollar, then it may still decline, as it is now doing. So the CBs have to start thinking more about “intervention”. With the dollar showing so much volatility over the past couple of years especially, pegging to it isn’t turning out to be much fun.

    Maybe the peggers need a new round of the global crisis to cause global investors to rush back into the dollar in renewed risk aversion, so the dollar won’t continue its slide for now. Sarcasm. But this could unfold. Where I’m most worried, though, is down the road a year or two, when the dollar’s fundamentals get so ugly that investors don’t even see it as a place to take refuge in the storm.

  • Posted by Mitul Kotecha

    Your comment that central banks have become more active in terms of intervention as the dollar weakens against major currencies is consistent with the market chatter at present in Asia. Many Asian central banks are likely to be unwilling to see their currencies strengthen significantly at a time when exports remain under a huge degree of pressure.

    Nonetheless, the trend of diversification into other currencies has been ongoing for several years. Admittedly it is a slow process and no central bank would likely want to fuel a dramatic slide in the dollar and/or a sell of in US Treasuries given that central banks would end up damaging the value of their own holdings.

    Although the dollar is unlikely to quickly lose its role as the world’s reserve currency central banks in Asia have realised that they are heavily exposed to dollar assets, especially US Treasuries and are likely to continue to look for alternatives in the form of other currencies as well as commodities.

  • Posted by rd

    Please keep in mind that it wasn’t the Saudis, or Iranians, or Chinese, or Russians who went in a recaptured Kuwait in the Gulf War. It was the US.

    I doubt if the Saudis et al want to give up the US military umbrella in the near future. I don’t see them from pushing away from the dollar peg in the near-future.

    I am sure that the Saudis are looking at the Brazilian economy and trying to figure out what happens to their own if the US focuses on becoming energy self-sufficient using bio-fuels and other alternative energy forms. The thought of American electric cars powered by nuclear or coal-fired power plants probably keeps them awake at night. If the Us went there, the Chinese would probably follow in short order.

    The US economy and governments are tripping all over themselves these days, but no serious student of economic history should forget what the US economy did in the transition from the Great Depression to World War II. The last thing the Arabian peninsula wants to see is the US address energy the way they did World War II. Attacking the US dollar would be a major way to precipitate that.

    While China, Russia and Iran would like to see the dollar come down a notch or two in importance, I don’t think other major oil players like the Saudis and Canada are in as big a rush.

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