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Devaluation Chatter Rising But No Dollar Danger Yet

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Tuesday, 19 May 2009 10:59 AM Current | Bio | Archive

Despite the apparent, but likely temporary, resilience of the U.S. dollar, there are a couple interesting developments in the currency world that should remind us that the dollar is not the world's only reserve currency, but the leading one.

Besides the unexpected bad housing numbers this morning in the United States, today’s lead headline certainly pertains to Brazil and China’s purported plans for non-U.S. dollar bilateral trade transactions in the future.

According to Brazil's central bank, Brazil and China are actually working on a plan to use their own currencies and not the dollar for their bilateral trade transactions (2008 China/Brazil bilateral trade was just under $44 billion.)

The idea of replacing the dollar with the Chinese yuan (CNY) and the Brazilian real (BRL) as trade currencies between them was in fact first openly discussed at the latest G20 summit in London on April 2. Take care, they are not talking about using currency swap agreements like the one earlier agreed on between Argentina and China, but instead using their own currencies for bilateral trade transactions.

Maybe not a headline but nevertheless a more important indication of the dollar’s future use as reserve currency could come from the just-released annual report of the Russian Central Bank that informs the share of euro (EUR) in Russia’s foreign currency reserves, which are the world’s third largest, has overtaken the leading share of the U.S. dollar (USD).

The EUR share stands now at 47.5 percent and the USD is at 41.5 percent.

Since last year, Russia has also banned all investment in U.S. agencies such as Fannie Mae and Freddie Mac, but it has kept more than 30 percent of its reserves in U.S. Treasuries and about 60 percent in European bonds.

Meanwhile, latest New York custodial flow data also show increased investment flows into the eurozone. It’s also good to remember the ongoing EUR’s relationship since early 2007 of 91 percent correlation between the price of oil and the path of EUR/USD. This relationship could be explained by the ongoing diversification of oil revenues that end up, in part, in foreign exchange reserves.

There is no doubt that European leaders don’t feel happy with these developments and the consequently further upward pressure on the euro. It looks like EUR’s outlook is apparently more defined by sentiment pertaining to the global economic outlook and not the eurozone per se.

At a moment when the Eurozone economy is in a rather more delicate state than at any point in its history, together with an imminent period of negative annual inflation rates, it can be expected that eurozone finance ministries could become very intolerant once the euro should hit the $1.40 marker again.

In this context, the UK Daily Telegraph just drew attention to comments from Airbus that suggested the company would be “cooked” if the EUR exceeded USD $1.30 “for long.” The anxiety of the people of Airbus is understandable because EUR/USD is still some 15 percent above its post-millennium daily closing average, notwithstanding it’s actually more than 10 percent below its 2008 highs.

Jean-Claude Trichet, president of the ECB in late April notably reminded U.S. Treasury Secretary Timothy Geithner that a "strong USD is in the interests of the United States'," in a clear allusion to the fact that U.S. monetary and fiscal policies are ill-disposed to provide support for the greenback.

In my opinion, a renewed era of verbal intervention has already begun, and we will hear much more from the likes of Mr. Trichet on this matter before too long.

In clear English: Notwithstanding at this moment all indicators on the surface seem going against the dollar, we’ll have to wait see what central bankers are able and willing to do to weaken their currencies against the dollar and, of course, if they will be ultimately successful.

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HansParisis
Despite the apparent, but likely temporary, resilience of the U.S. dollar, there are a couple interesting developments in the currency world that should remind us that the dollar is not the world's only reserve currency, but the leading one.Besides the unexpected bad...
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2009-59-19
Tuesday, 19 May 2009 10:59 AM
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