June 11, 2006

USD shift in reserve currency status confirmed - call it 10% per year

Below are some figures below about how the USD is now losing some of its power as world currency. Note that this has been expected for many years now, but obviously if you are one of the CBs that wants to shift reserves, you want to do it without stating it. So we've had to sit here on the prediction for some time, biting our fingernails.

On Thursday, June 8, Russia became the latest in the list of countries that shifted a part of its Central Bank reserves from the dollar. Sergei Ignatyev, chairman of the Central Bank, said that only 50 percent of its reserves are now held in dollars, with 40 percent in euros and the rest in pounds sterling. Earlier it was believed that just 25-30 percent of Russia's reserves were held in euros, with virtually all the rest held in dollars.

Let's do the maths, so as to explain why this is significant. If we take the shift as from 60% to 50%, allowing euros to rise from 30% to 40%, then we see a relative shift in USD demand of say 20%. Call it over 2 years, and we can guess at a shift of 10% per year in the total international currency use of USD.

If all countries are doing this - and there are good game theory, trade and geopolitical reasons to suspect this - then we see a massive washing around the world of some 10% of the USD during the space of a year. This will go on until we reach a new stability, a level which is anyone's guess at the moment.

What then happens to the "value?" Obviously, the music stops at some point. Now, my macroecon is a bit rusty, but here's what I think happens. Most of the money bounces around the world and demand then exceeds supply, so the prices starts dropping. As there is a clear need to totally get rid of a substantial lump of it, this goes on until that is "got rid of." But how do we get rid of currency? Who takes it back these days?

The mechanism for this apparent paradox is US assets. As the USD price goes down, US assets start to look cheaper and cheaper. So more and more of the value finds itself coming out of the international washing machine and into the US markets. Stocks (shares, companies) and real estate. IP catalogues. Money market investment. Anything available that will be for sale in USD will be purchased.

Now, the sellers of these things will either be foreigners (in which case nothing changes, the music is still playing) or they will be US persons, in which case, they are happy to hold dollars. Demand for dollars is always firm in the US, by definition.

So the music stops when that above value lands in the US. The foreign dollars are exchanged for US assets. A great sell-off, in other words.

But wait - what happens to the dollars then? Well, there are now too many of them in the US. Now we see why the US economy is continuing to boom. The dollars are coming back home, and *effective inflation* is running at the amount calculated above.

(Well, it's a bit worse than that. 2/3 of the dollar is outside the US. So a 10% shift from outside to inside means a doubling effect on local dollars. Yup, there is in these assumptions a 20% increase in the number of dollars washing back to the US every year, but bear in mind these are napkin numbers.)

What does this mean? Likely that the housing bubble will not burst, or not burst so aggressively. Likely that businesses will find plenty of cash for loans, so they'll be running on infinite credit. The stock market is still pointed up! But prices will be shifting against companies and individuals in a fairly significant jolt of inflation, and what's more, the Fed won't be able to curtail it as it normally does.

To stop it, the Fed would have to soak up that liquidity. How's it going to do that? Issue more bonds? Hmmm, there's a thought. Is the massive debt increase over the last 6 years really nothing to do with the administration, but it is all the flip side of soaking up the wash back? Any real macroeconomists in the house? Can we do some napkin numbers on how much additional debt has been issued and how much currency is washing in? (Ed: Confirmation?)

Full article:

Russia Shifts Part of Its Forex Reserves from Dollars to Euros

Created: 09.06.2006 11:02 MSK (GMT +3), Updated: 16:06 MSK MosNews

On Thursday, June 8, Russia became the latest in the list of countries that shifted a part of its Central Bank reserves from the dollar. Sergei Ignatyev, chairman of the Central Bank, said that only 50 percent of its reserves are now held in dollars, with 40 percent in euros and the rest in pounds sterling. Earlier it was believed that just 25-30 percent of Russia's reserves were held in euros, with virtually all the rest held in dollars.

Russia's gold and foreign currency reserves have grown rapidly over the last few years in tandem with high oil and gas prices. As MosNews has reported earlier, Russia currently has the world's fourth-largest reserves, after China, Japan and Taiwan, and it looks to overcome Taiwan by the end of the year, with reserves growing by $5-6 billion monthly.

The Russian Central Bank's move ties in with increasing signs that Middle Eastern oil exporters are also looking to diversify their reserves out of the dollar. "This is a bearish development for the dollar," Chris Turner, head of currency research at ING Financial Markets, told the British Financial Times. "It reminds us that global surpluses are accumulating to the oil exporters, and Russia is telling us that an increasingly lower proportion of these reserves will be held in dollars. This suggests there is a trend shift away from the dollar."

Clyde Wardle, senior Emerging Market Currency strategist at HSBC, told the paper: "We have heard talk that Middle Eastern countries are doing a similar thing and even some Asian countries have indicated their desire to do so."

Moscow's move was unsurprising. Russia's $71.5billion Stabilization fund, which accumulates windfall oil revenues, is due to be converted from rubles to 45 percent dollars, 45 percent euros and 10 percent sterling. The day-to-day movements of the ruble are monitored against a basket of 0.6 dollars and 0.4 euros. About 39 percent of Russia's goods imports came from the eurozone in 2005, against just 4 percent from the US.

The statement plays into a perception that central banks, which together hold $4.25 trillion of reserves, are increasingly channeling fresh reserves away from the dollar to reduce potential losses if the dollar was to fall sharply.

Copyright 2004 MOSNEWS.COM
http://www.mosnews.com/money/2006/06/09/dollarshift.shtml

Posted by iang at June 11, 2006 01:29 PM | TrackBack
Comments

Quoting: "What does this mean? Likely that the housing bubble will not burst, or not burst so aggressively. Likely that businesses will find plenty of cash for loans, so they'll be running on infinite credit."

Response: The flood of dollars returning to the U.S. will cause higher dollar prices in commodities, exportable products, consumer products, and in any industrial assets related to production of the same. This will be seen as inflation by the U.S. consumer, and as a falling dollar by foreigners. When inflation runs high, or a currency is falling, interest rates rise because lenders know that inflation or devaluing currency puts them on the losing end of the stick. Lenders won't lend unless they get enough interest to compensate them for expected inflation. Rising interest rates will kill the housing bubble and the bond market. When the bond market goes down, so do stocks. So unless the dollar goes into hyperinflation, we can look forward to a long term bear market cycle of declining prices in stocks, bonds and residential housing. We can look forward to a long term bull market in commodities. Industrial real estate related to the production of U.S. exports will probably continue to rise, because it hasn't been in a speculative bubble as residential housing has, and because foreigners will buy U.S. exports and the whole production chain that produces them.

Posted by: Vincent at June 13, 2006 08:57 PM

http://www.unknowncountry.com/news/?id=5349 adds some confirmation:

"There is evidence that the US is attempting to manage the decline by purchasing its own debt. As Asian purchasing of US paper declined last month, the slack was taken up by Caribbean and UK banks that would not normally have the liquidity to make such purchases. Therefore, they are acting for a third party, and the only party that would buy dollars when a loss in value is inevitable is the US Treasury."

Posted by: " Dollar on the Edge" at June 23, 2006 06:34 AM

The USD had to go. Too many scumbags playing with it. Now we have oil which has made everyone in the world to pay up which currency attacks could not do.

Posted by: Annamalai Sundrasan at June 15, 2008 02:11 AM

The USD had to go. Too many scumbags playing with it. Now we have oil which has made everyone in the world to pay up which currency attacks could not do.

Posted by: Annamalai Sundrasan at June 15, 2008 02:11 AM
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