Monday, November 08, 2004

If this rumor turns out to have legs, we could see a massive run on the dollar this week.
the market has been rife with rumours that the latest wave of selling has been led by foreign governments seeking to cut their exposure to US assets.

India and Russia have reportedly been selling US assets, as well as petrodollar-rich Middle Eastern investors.

China, which has $515bn of reserves, was also said to be selling dollars and buying Asian currencies in readiness to switch the renminbi's dollar peg to a basket arrangement, something Chinese officials have increasingly hinted at. Any re-allocation could push the dollar sharply lower and Treasury yields markedly higher.
As you close observers know, foreign private capital has lost interest in dollar denominated assets. In August (the latest month for which we have data) it fled both US stocks and US treasuries. The only things both holding up the dollar and funding the US federal budget deficit are the Bank of Japan and the People's Bank of China.

If China not simply shifts its peg but abandons a dollar peg altogether in favor of a basket, then Japan has much less incentive to buy the dollar. The dollar can fall but the renminbi (and perhaps the other pegged or heavily managed Asian currencies) will not follow lockstep in tow, keeping Japanese exports competitive in these all-important markets.

Interest rates on the 10-year treasury bond shot up almost 12 basis points on Friday. A sign that Asian (and Russian) central banks are really starting to bail on the dollar? And thus put a swift end to low interest rates?

As they say on Rugrats, "Hang on to your diapies, babies!"


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