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Supposedly everyone hates the US dollar, which has been punished, it seems, for the punk US economy, America’s massive debts, and a Fed that seems destined to keep interest rates at 0% from now until eternity.People constantly talk about moving away from the dollar: to euros, to gold, the yuan, to whatever else.
And yet… it turns out that there hasn’t been any dollar dumping. At all.
Around the world, currency reserve managers of various countries haven’t slowed down their purchases of dollar one iota, as this chart from Citi’s Steve Englander makes obvious.
So why hasn’t anyone been able to dump dollars?
Englander has two basic theories:
First, if reserve managers as a group pull back from buying USD, the USD will fall. In theory, cheaper USD assets will induce private sector buying to fill the gap that exists between supply and demand. The question is whether the crowding in of demand by a cheaper USD occurs fast enough to mitigate concerns about loss of competitiveness among finance ministries, central banks and even reserve managers. On this we have doubts.
So one answer is that policymakers are unwilling to take big risks on competitiveness and therefore return to reluctant USD buying whenever the USD selling pressures are too extreme.
The second obstacle to diversification is that reserve manager’s portfolios are too big relative to the size of the market and have been for some time. We estimate that active EM reserve managers own about USD 6.5trn of reserves. If they were to try and diversify even 10% out of USD, the USD 650bn selling wave would be difficult for the market to absorb, even if spread over a couple of years. (The US current account has a run-rate of USD 450-500 bn – do the thought experiment of considering where the USD would be if you added 50% additional USD selling to the current account deficit for three years.) Again, the issue is whether reserve managers are willing to absorb the valuation hit from selling the USD that they would like to sell and the answer is by and large ‘No’. They seem content to keep USD shares relatively stable, adding as little as they can, and selling opportunistically whenever possible.
So basically the dollar’s best defence is its size. It’s basically unsellable, and there’s no other asset of scale to fill the void.
The same can be said of US Treasuries: Even when people start feeling fears of US default, or Moody’s warns on the US credit rating, Treasuries rally, and the answer is: There’s just no “risk off” safe-haven asset of any scale. Not everyone can jump into Swiss Franc when they get scared. Oil isn’t liquid, and invariably, despite its reputation for being safe, it always gets liquidated come panic time (like this morning).
So the conundrum remains
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