from Follow the Money

Dow Jones: Central banks do not seem to be dumping dollars

December 10, 2004

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That’s the tag on p. C4 of the Wall Street Journal.

The smart money -- and regular readers of this blog -- know that this is real question is not whether central banks are, in aggregate, dumping dollars, but whether central banks are willing to keep on buying dollars and then to invest those dollars in dollar denominated securities.

Even with the change in the dollar/ euro, I suspect the US will have a substantial, $650 billion plus current account deficit next year -- assuming US growth remains strong, the US fiscal deficit does not fall below $350 billion and oil is in the high 30s or low 40s.

Financing that deficit at current exchange rates (vis a vis Asia) and current interest rates required $440 billion of net central bank purchases of dollar assets in 2003, a comparable amount in 2004 (we don’t have the final data, but some indicators suggest that if anything the pace of central bank financing has if anything picked up slightly), and no doubt a similar amount of new central bank financing in 2005 and 2006 -- unless something radical changes.

In that context, some smaller central banks can shift out of dollars into euros at the margins so long as the really big players are continuing to accumulate dollar assets. Dow Jones reporting (relayed to me by reader Marcel) suggest that the People’s Bank of China accumulated $20 billion of reserves in the month of October. That has yet to be confirmed on the PBoC’s web page, but let’s assume its true. If those reserves are mostly going into dollars, that is a lot of new money that at least one central bank is investing in various parts of the US bond market ...

Put differently, $20 billion from China would single handedly finance a third of a $60 billion monthly current account deficit (a $720 billion annual deficit), or 40% of a $50 billion monthly current account deficit ($600 billion annual current account deficit). Alternatively, the $20 billion in new financing from China could be letting other central banks reduce their dollar holdings by $5 billion a month and still provide the US with $15 billion a month --

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