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February 24, 2005
Central Banks Are Diversifying? Of Course.
Brad Setser has several posts in the last few days -- here, here, and here -- noting the great excitement over a report that Korea plans to diversify its portfolio away from dollars. There was this, from a Bloomberg report on Tuesday that Brad links to...
The dollar fell the most in more than a week against the euro and dropped versus the yen, Korean won and the Canadian and Australian currencies after the Bank of Korea said it plans to diversify its reserves.
South Korea's central bank, which has a total $200 billion in reserves, said in a report to a parliamentary committee on Feb. 18 that it will increase investments in assets denominated in currencies such as the Australian and Canadian dollars. Korean investors, including the central bank, are the fifth-biggest foreign holders of U.S. Treasuries.
... that included this breathless conclusion:
"Support for the dollar is quickly disappearing,'' said Kenichiro Ikezawa, who manages $1 billion in overseas debt at Daiwa SB Investments in Tokyo. ``This Korean story is having quite an impact because it feeds into suspicion that others are also seeking to cut their exposure to the dollar.''
Apparently, the Koreans (and others) weren't all that happy with that conclusion, as here is yesterday's news, from The Financial Express:
The dollar advanced in Europe after Japan’s ministry of finance and South Korea’s central bank said they have no plans to reduce US currency holdings. Taiwan’s bank said it hasn’t been selling dollars. The announcements by Japan, Korea and Taiwan, accounting for three of the world’s four largest currency reserves, came a day after the Bank of Korea sparked the biggest drop in dollar against the euro in more than six months by saying it planned to change the composition of its holdings.
The three central banks have a total of $1.26 trillion in reserves. ‘‘They’re trying to put out the fires caused by the comments on diversification on Tuesday,’’ said Toshi Honda, a currency strategist in London at Mizuho Corporate Bank, a unit of Japan’s biggest lender. ‘‘Today’s denials are having an impact and we’re seeing the dollar rebound.’’
I don't think the point is that diversification will not happen. The point is that it is in everyone's interest for that adjustment to be orderly, that central banks intend to make it so, and that diversification will likely occur at the margin (that is, not in the form of widespread "dollar dumping").
I am on record as buying into the inevitability of an adjustment in U.S. current and capital account positions. But I am not convinced by the doomsday scenarios, and the history of these things does not shake my confidence.
UPDATE: The picture of dollar reserve positions that orginally accompanied this post was WRONG, so I have removed it. A follow-up will be forthcoming.
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