Saturday, December 02, 2006

Foreign Central Banks Are Not Just Jawboning

Rumor has it that the Chinese, Japanese and Korean central banks are just bluffing when they threaten to lower their appetite for US dollar instruments. This may be so, given that these three have huge advantages to lose in terms of their export industries; but here are some figures about which other holders of our dollars are putting them where their mouth is.

westerJaws
[Thanks to math.unm.edu/~wester for the picture.]

From Prudent Bear, we have this:

'November 28 – Bloomberg (Michael Heath): “Russian inflation is slowing as the population switches savings to rubles from dollars, the Organization for Economic Cooperation and Development said. Russia has managed to combine rapid money-supply growth with a falling inflation rate due to the ‘on-going de-dollarization’ of the economy, the Paris-based organization said…”'

And from Sir Chartsalot, this:

"[In June of 2006,] Russia revealed that it had reduced its US$ exposure by 20% to 50% of its foreign exchange reserve, while boosting the Euro to 40% from 25% earlier."

And this:

"Italy’s central bank slashed its US dollar reserves to 63% from 84% in the first half of 2006, while holdings of sterling rose to 25% from zero in 2004."

This is no laughing matter, which is a pity for a gadfly like me, but sometimes you just have to be serious. The Federal Reserve must begin to realize how much of a sticky situation they will be in within the next few years. If they try to squeeze out the remaining excess money supply by raising their rates again, they will hurt the US economy, but they will support the dollar, upon which the economy ultimately depends. (Ideally, they would stop providing the excess in the first place and avoid this whole mess the next time around.)

However, if they take the path of least resistance and lower the rates to underpin the slagging housing market and consumer sentiment, they will gravely injure those foreigners who hold US assets of all kinds, burning these trusting trade partners and the confidence they have placed in our monetary wisdom, for many decades to come.

Perhaps that's not such a bad thing. The 1980's apparently weren't painful enough. It will bring the US down another peg and take the pressure off of our Lonely Long-Distance Runner Fed.

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