"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Monday, March 14, 2011

OPEC Slashing US Treasury Holdings, Dollar Weakens

One thing I often write about regarding the value of fiat money, is its use by trading partners around the world.  There is a process of recycling going on, where surplus nations buy the debt of their trading (oftentimes trade deficit) partners.  

The issuance of government debt gives nations with surplus foreign reserves a place to park their cash and earn interest.  So long as the value of their investments is maintained, the trading relationship continues, and in the case of the US Dollar, it's reserve status is maintained.  Keep in mind, the current debt for trading paradigm is merely 40 years old.  The use of gold as a foreign reserve asset no longer plays a role in limiting global imbalances.  I'm not saying the gold standard era was perfect - but it did not allow for the outrageous imbalances we have today to form either.

And so we have a recent development.  It could be temporary, or it could be a trend.  There is a lot going on in the world today, and identifying trends is tricky.  Time needs to march on a little longer in order to gain some clarity on where we are going.  The trend is of a decreasing share of US Dollar global foreign exchange reserves... so far.  And now we can add OPEC to the list.  From Bloomberg/Businessweek, emphasis mine:
Dollar Depressed by OPEC Slashing Treasury holdings by 9% 
March 14 (Bloomberg) -- Oil-exporting countries are cutting holdings of U.S. government debt as energy prices rise, helping depress the dollar, the worst-performing major currency of the past six months. 
Treasuries owned by oil producers and institutions such as U.K. banks that are proxies for Middle East nations fell 9 percent in the second half of 2010 to $654.6 billion, the first decline in the final six months of a year since the Treasury Department began compiling the data in 2006. The sales may continue, if history is any guide, because Barclays Plc says Middle East petroleum exporting nations have traditionally placed only 25 percent of their savings in dollar-based assets. 
“Middle Eastern oil exporters are now getting this extra windfall of dollars and the question is on the margin what they want to do with that,” said Jeffrey Young, the head of North American foreign-exchange research at Barclays in New York. “It’s dollar negative” unless political risks around the world increase and spur demand for the safety of U.S. assets, he said. 
The appeal of the dollar has diminished as the Federal Reserve keeps interest rates at almost zero, prints cash to purchase $600 billion of bonds in a policy known as quantitative easing and the budget deficit holds above $1 trillion. The currency fell to 61.3 percent of global foreign-exchange reserves in the third quarter, from a peak of 72.7 percent in 2001, the latest International Monetary Fund data show. 
Biggest Gains 
The 12 members of the Organization of Petroleum Exporting Countries -- Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela -- provide about 40 percent of the world’s oil. While it’s almost impossible to trace the flow of their dollar revenues from crude sales, the biggest gaining major currencies over the past six months based on Bloomberg Correlation-Weighted Indexes are Sweden’s krona, Norway’s krone, the euro, franc and Australia’s dollar, all rising more than 2 percent. 
Currency Forecasts 
The euro may fall to $1.30 by year-end, Halpenny said. The median estimate of 44 strategists and economist surveyed by Bloomberg is for the currency to weaken to $1.35. Japan’s yen may depreciate to 88 per dollar, a separate poll shows. 
“There is relatively persistent global demand for dollars even with a structural trend of it slightly declining over time as a percentage of overall asset holdings,” said Jens Nordvig, a managing director of currency research in New York at Nomura Holdings Inc. “That will be true for Middle Eastern central banks as well as the alternative, the euro, is not looking like a clear winner because of fundamental reasons.” 
As the dollar’s share of global reserves has fallen, the IMF’s report shows that holdings categorized as “other,” which excludes dollars, euros, British pounds, yen and francs, rose to 4 percent of the total, the highest on record.
Full article HERE.

There is a twist to this story. As the dollar depreciates, US exports are boosted.  But this too has another consequence - a nation that controls the world's reserve currency can not run a trade surplus.  See Triffin's Dilemma.  The US is far from having a trade surplus, but increasing exports decreases the amount of dollars that are being exported via a trade deficit, dollars that are needed for the world economy to grow.  Unless, of course, nations begin to enter into non dollar denominated bilateral trade agreements.  Kind of what China is doing right now.

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