GREENBACK DECLINE PROMPTS TALK OF CENTRAL BANK RESERVE DIVERSIFICATION AND ENDING PEGS TO DOLLAR
The shifting sands in the foreign exchange market in 2007 undermined the dollar to the extent that China openly weighed what its state media refer to as the uclear option?of dropping its vast holdings of US securities if Washington were to impose trade sanctions to force a quicker revaluation of the yuan. A weak dollar is not in the best interests of US creditors, who will be paid back in cheaper greenbacks.
Meanwhile, Jassem Al-Mannai, chairman of the Arab Monetary Fund, based in Abu Dhabi, UAE, recommended that members of the Gulf Cooperation Council end their currency pegs to the dollar to give themselves more flexibility to combat rising inflation. He suggested that the GCC countries peg their currencies to a basket of currencies, including the euro, the British pound and the Japanese yen, or shift to a managed float.
The GCC declined to follow Al-Mannai advice at its summit meeting in Doha, Qatar, in December, with Saudi Arabia adamant about maintaining the current system. The dollar role as the world leading reserve currency, however, is looking less secure.
ontinued talk of repegging and revaluations is a reminder of the global impact of the decline in the value of the dollar, causing central banks and sovereign funds to rethink their positioning regarding reserve accumulation, currency regimes and oil pricing,?says Ashraf Laidi, chief foreign exchange analyst at New York-based CMC Markets US. uch comments from China have been a veiled counter threat to the growing protectionist rhetoric by Democratic presidential candidates and the US Congress calling for restrictive legislation against China in the event that Beijing didn revalue its currency,?he says.
China, Japan Sell Treasuries
Both China and Japan, the largest holders of US treasuries, have reduced their holdings of these securities, with Japan total falling to a three-year low of $582 billion and China to a six-month low of about $397 billion at the end of the third quarter of 2007, Laidi says. This trend could continue in 2008 if the dollar weakens further, eroding the value of their reserves.
China announced in late November that its foreign exchange reserves, the world largest, had climbed to $1.46 trillion in October, up $21 billion in one month. However, that was the smallest rise since September 2006. After rising at about $45 billion a month in the first seven months of 2007, China foreign exchange reserves rose by just $23 billion in August and $24 billion in September 2007. The slowdown seemed to indicate the country was diverting its trade surplus away from US treasury securities and into stocks and corporate acquisitions controlled by its sovereign wealth fund.
It is not possible to determine from the data published by the US Treasury Department and the Federal Reserve exactly which foreign investors own US debt and how much is in foreign hands. It is clear, however, that the United States is vulnerable to sudden decisions by foreign holders to make large-scale sales of their dollar assets. So far, any selling that has been detected has been gradual rather than sudden.
US and China Rely on Each Other
hina is in a bit of a tough spot,?says Todd Crosland, chairman and president of Salt Lake City, Utah-based Interbank FX, a futures commission merchant specializing in the retail foreign currency market. he US is China largest trading partner and has a significant trade deficit that has to be financed,?he says. The countries are locked in a mutually beneficial relationship that depends on the US buying China exports and China buying US treasury securities.
If either China or Japan were to aggressively sell some of their dollar holdings, it would only hurt the value of their remaining holdings, Crosland says. hile there has been talk of the euro gaining as a reserve currency, I do not see a significant shift happening,?he says.
China wants to avoid using the uclear option?of a mass liquidation of its vast holdings of US treasuries, says He Fan, a researcher with the Institute of World Economics at the China Academy of Social Sciences. However, he made it clear in a report in the China Daily newspaper that China has the power to trigger a dollar collapse. hina has accumulated a large sum of US dollars,?he said. uch a big sum, of which a considerable portion is in US treasury bonds, contributes a great deal to maintaining the position of the dollar as an international currency.?br />
As long as the yuan is stable against the dollar, China is unlikely to shift its reserves out of dollars, He said. Nonetheless, he Chinese central bank will be forced to sell dollars once the renminbi [yuan] appreciates dramatically, which might lead to a mass depreciation of the dollar against other currencies,?he told the China Daily. The yuan has appreciated by about 10% against the dollar in the past two years, and China has resisted international pressure to speed the pace of the yuan ascent.
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