PetroDollar wrote:
$this->bbcode_second_pass_quote('', 'O')k, here's some information to consider: The dollar share of global reserves peaked at 71.4% in 2001, and fell to 64.7% as of end-2006. (I don't have BIS data for 2007, but based on various news reports since mid-2007 regarding the selling of US treasuries by Japan and China, I expect the dollar's reserve currency role has eroded quite significantly). Thru 2006, the decline in the dollar was roughly equivalent to the ground made up by the euro - so Euric and many others see this as encroachment into the dollar's role as the world's premier reserve currency - but apparently you do not share that viewpoint. (euro-skepticism, perhaps?)
PeakOil is You
Euro vs Dollar devaluation back door
Re: Euro vs Dollar devaluation back door
by MrBill » Tue 23 Oct 2007, 04:06:20
Not at all. I have always underlined the risks to the US dollar's dominant position as 'an investment currency' or 'store of wealth' due to the US' large trade and current account deficits as well as their equally large unfunded future liabilities like pensions and healthcare for a retiring Baby Boomer generation.
Also I have lived in Europe for 15-years and have publicly said here that two-thirds (actually three-quarters now) of my savings are invested in euro assets (while some are in Canadian dollar and Sterling assets), while those US dollar assets I do own are in oil cos. and Blue Chips that earn a significant portion of their earnings outside the USA. So I am hardly a euro sceptic.
What I have said is that in the long-term countries like Italy, Spain, France and Greece (the Club Med countries in the euro) need to improve their labor productivity and not rely on a weak euro to remain export competitive. Low, slow growth and ten years of painful labor market and company reforms have reversed Germany's fortunes as they have been able to dramatically reduce their per unit labor costs and boost exports. Germany being the world's largest exporter two years in a row.
The danger to the euro is that a strong euro that makes Italian and French exports uncompetitive, while making Asian imports more competitive will exacerbate these countries' fiscal imbalances (because the ECB only controls monetary policy) and under the Maastricht Criteria these countries can be punished for their prolifigy. Some may be forced to voluntarily (or involuntarily) leave the ERM if they are unable to reform themselves. That day may be far into the future, but it is certainly not outside the realm of possibility. That would be the dark underside of the euro's silver cloud at the moment vis a vie the US dollar's current problems.
Also with regards to the US dollar it is clear (to me and some others) that we have several components that are structural and not cyclical to global imbalances. One is that a weak US dollar relative to its competitors should help make US exports more competitive. It has. But secondly, there is somewhat of a savings glut and as we all should know by now one country's current account surplus is automatically another's deficit. So if OPEC and non-OPEC producers as well as Asian exporters are exporting both goods and capital then it is extremely hard for the US to close its own current account deficit. Which is by no means an excuse. America saves too little and US governments spend too much. Even if the trade deficit were closed (hard due to oil imports) they would still be left with their own budget deficits as well as those unfunded future liabilities that I already mentioned.
Euric, thanks for correcting me on those foreign exchange reserve ratios. I will have to cross check them because I do not trust the accuracy of Wiki, but it was dumb of me to quote a number off the top of my head without checking first.
I certainly think the US dollar is at risk as sovereign wealth funds switch out of low yielding US treasuries and into alternative assets. So the ratio may fall from 60-65 percent for the US dollar to less. However, my point was that since the introduction of the euro in 1999, and after the Asian financial crisis, the total amount of foreign exchange reserves has increased dramatically. So even if the ratio slips a little for the US dollar in favor of the euro there are still more US dollar assets being held by foreign governments and their investment agencies.
This is really hard to track reliably. Really hard because capital flows are by their nature opaque. However, if you keep in mind that the US consumes two thirds to 70-percent of the world's savings, and that current account deficits have to equal surpluses then it is not hard to figure it out on a macro-level that as America's debts and deficits balooned that the rest of the world lent more money on aggregate to the US to cover those deficits. That is a fact. It might not have been direct foreign investment. It may have come through conduits, offshore financial centres, and/or via cross currency swaps for example. The point is that the deficit always gets funded even it is somehow in an intransparent manner.
But as for foreign exchange risk. If you leave aside interest rate, settlement and counterparty risk that are seprate issues, you are left with three specific types of foreign exchange risk. They are
- transaction risk (spot risk)
translation risk (balance sheet risk)
economic risk (competitive advantage risk)
so all firms domestic and international, including oil producers and Asian exporters, run FX risk whether or not they hedge them or not.
As oil is produced around the world in local currency, and then perhaps sold in US dollars, all these firms run economic risk. That is that their local costs of production increase as their currencies appreciate and their exports receipts are worth less in local currency terms.
The spot risk is actually the easiest to manage with freely convertible currencies. But even if the local currency is pegged to the US dollar (either formally or informally through intervention) it does not eliminate economic risk.
One example being the country that exports in US dollars, but imports mainly in euros. It is running an open foreign exchange position. It does not have to hedge that position, but it still exists. Sometimes the cost of hedging is not economical or practical. However the risk does not simply disappear because it is ignored.
These risks can be mitigated by repatriating export receipts; allowing their own domestic currencies to rise; investing that money into their own local capital markets; and developing their domestic economies. That causes its own set of economic risks as it makes exports less competitive, but it should be offset by lower imported inflation, higher purchasing power for the local economy, and, hopefully, rising levels of productivity as capital is substituted for labor.
Translation risk is probably the least intersting from our point of view. It is firm specific. It arises for example when an oil company operates at home, but has operations abroad. Those operations abroad may be earning profits, but if the local currency appreciates too much they may be reflected as foreign exchange losses when those profits are converted (from a bookkeeping standard) back into local currency. It is not archane, just not central to our argument.
But, yes, as per my previous post, I do see a risk to the US dollar's role as premiere reserve currency, and as a store of wealth in any case, due to the US' current account, budget, trade and balance of payments (BOP) deficits. But never the less I still firmly assert that any loss to the US dollar in the basket of these central bank or sovereign fund's holdings will have to be made up elsewhere. So far they have only shifted the imbalance from the US dollar onto the euro. That is equally unsustainable in the long run. As is shifting from low yielding treasuries to alternative assets. The only solution to global imbalances is to develop their own capital markets and grow their own domestic economies. To cease relying on offshore only growth models where they export both goods and capital to consuming nations. And we are not there yet.
UPDATE: RE translation risk.
Sorry, of course, central bank foreign exchange reserves and sovereign investment funds are subject to FX translation risk. Therefore, it is central to our argument, not beside the point. We have to compare investment results of actively placing reserves abroad in a foreign currency versus repatriating it at home. If there is a cost it has to be recognized. The same as if a sovereign fund buys equity and it declines in value.
p.s. I am away until next Tuesday, so I will have no chance to refute your counter arguments until that time. Thanks.
UPDATE II: why structural imbalances are not self-correcting - the IMF estimates that global reserve growth is set to top $1 trillion in 2007. That means someone else needs to run a $1 trillion deficit to absorb those reserves. Any guesses?
$this->bbcode_second_pass_quote('', 'F')irst, so long as China resists allowing its currency to appreciate – a policy that requires that China buy tons of dollars in the foreign exchange market and invest tons of money in the US – any emerging economy that allows its currency to appreciate against the dollar also allows its currency to appreciate against the RMB. That has a real cost. Ask India. Or Thailand. Those emerging Asian economies that have allowed their currency to appreciate now generally run current account deficits, not surpluses – and many are seeing a very rapid rise in their imports from China. As a result, even countries with higher upfront sterilization costs than China are still intervening to resist pressure for their currencies to appreciate. Ask the Reserve Bank of India how many dollars it has bought over the last month. And then ask the Bank of Thailand.
Source: Emerging economies accomplish something beyond the reach of the G-7
Last edited by MrBill on Tue 23 Oct 2007, 09:56:00, edited 4 times in total.
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Re: Euro vs Dollar devaluation back door
by MrBill » Tue 23 Oct 2007, 04:56:57
PetroDollar wrote:
$this->bbcode_second_pass_quote('', 'O')f course another factor that is propping up of the dollar’s international demand as a reserve currency is its monopoly transaction status within OPEC et al. This pattern is illustrated by the huge increase in the price of oil from 2002 to 2005 and the commensurate hugeincrease in dollar holdings by foreign banks (most often Treasury bills) despite the Federal Reserve’s abnormally low interest rates during most of that period. In 2006, international investment analyst Jephraim P. Gundzik noted this important macroeconomic phenomenon in the Asia Times:
$this->bbcode_second_pass_quote('', ' ')
As of mid-2005, foreign investors, including foreign central banks, held] an estimated $6.6 trillion worth of US bonds and equities, up from less than $4 trillion in mid-2002. About 60% of this money is parked in long-term US Treasury, agency and corporate bonds. The rapid and sustained increase of international oil prices is the main factor behind the growth in foreign holdings of US securities and the external supply of dollars used to purchase these securities.
$this->bbcode_second_pass_quote('', 'O')f course another factor that is propping up of the dollar’s international demand as a reserve currency is its monopoly transaction status within OPEC et al. This pattern is illustrated by the huge increase in the price of oil from 2002 to 2005 and the commensurate hugeincrease in dollar holdings by foreign banks (most often Treasury bills) despite the Federal Reserve’s abnormally low interest rates during most of that period. In 2006, international investment analyst Jephraim P. Gundzik noted this important macroeconomic phenomenon in the Asia Times:
$this->bbcode_second_pass_quote('', ' ')
As of mid-2005, foreign investors, including foreign central banks, held] an estimated $6.6 trillion worth of US bonds and equities, up from less than $4 trillion in mid-2002. About 60% of this money is parked in long-term US Treasury, agency and corporate bonds. The rapid and sustained increase of international oil prices is the main factor behind the growth in foreign holdings of US securities and the external supply of dollars used to purchase these securities.
...Indeed, it was the huge demand for petrodollars due to high oil prices — and certainly not high yield
So, of course, as you and I both (should) know, the Fed sets short-term interest rate policy, and has no (direct) control over the yield on 'long-term US Treasury, agency and corporate bonds' much less equities.
Also, as has been pointed out too many times to mention there is no additional demand for US dollars to pay for oil even if it is more expensive.
Sell EUR
Buy USD ( + )
Sell USD ( - )
Buy OIL
NET zero extra demand for USD to buy OIL. Where the extra demand comes from as you have pointed out is when oil producers re-invest those export receipts into USD-denominated stocks and bonds.
But that is an investment decision on behalf of oil exporters. They can repatriate their export costs to pay for local production costs, to pay royalties and taxes and to distribute profits to their shareholders. Or if they want they can buy euro denominated assets. Both are 100% completely independent of the decision to sell oil in US dollars.
The fact that they would re-invest in USD-denominated assets despite low yields does in my opinion point to a lack of investment alternatives, which is why so many exporters are so keen to set-up sovereign investment funds to explore alternatives other than the US dollar.
That would affect the value of the US dollar as the USA still imports oil, but it would have no offsetting purchase of USD-denominated assets to help offset the trade and balance of payments deficits.
UPDATE: why petro-dollars still flow back into the USA....
$this->bbcode_second_pass_quote('', 'C')all it coordination without any formal coordination. Almost every emerging economy is – or has – intervened over the past year to prevent their currencies from appreciating. And they all have done so without demand anything from the US in return, and by and large, without talking to each other either.
Second, high oil prices – and policy inertia in the oil exporting economies.
The oil exporters have a ton of cash with oil trading in the $85-90 range, even if many now need $40 oil – if not a bit more -- to avoid running an external deficit. Taking in $85 a barrel and spending $40 on imports leaves $45b a barrel to invest globally. It is – in that narrow sense -- equivalent to taking in $65 and spending $20.
The oil exporters don’t really have to worry about Chinese competition -- so that can hardly explain their continued willingness to peg to the dollar. So why have they joined the dollar financing carterl?
Inertia probably plays a bigger role than most would suspect. The GCC countries haven’t agreed on what should take the place of their dollar pegs in the run-up to their now-likely-to-be-delayed yet again monetary union. And so long as they peg to the dollar, they have an incentive to hold dollars – at least the bigger countries. Selling risks driving the dollar and thus the GCC currencies down.
Source: policy inertia in the oil exporting economies
.... because even sovereign wealth funds have to find a home for their hundreds of billions. We all live in the here and now. The past is gone and the future has not arrived. All investment is made today in the here and now. There is no alternative! ; - )
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