from Follow the Money

Korea, enough said

February 22, 2005

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It looks the remarks of Korea’s Central Bank President last week were a leading indicator of today’s big news: Korea plans to diversify its reserves away from the dollar!

Bloomberg is right: the real question is who [formerly, how -- oops] else follows suit -- Thailand already has shifted out of the dollar (look at how its reserves moved in January, when the dollar rose v. the Euro), Russia too. But most central banks are still massively overweight dollars.

``The market will now be looking to other central banks and what they will be doing, including the European central banks and Middle Eastern banks,’’ said Mansoor Mohi-Uddin, head of currency strategy at UBS AG in London. ``The market has got nervous and has continued selling the dollar.’’

...

``Support for the dollar is quickly disappearing,’’ said Kenichiro Ikezawa, who manages $1 billion in overseas debt at Daiwa SB Investments in Tokyo. Korea’s report ``feeds into suspicion that others are also seeking to cut their exposure to the dollar.’’

It will be interesting to see how far Korea is willing to let the won appreciate. Diversification in the context of rapidly growing reserves is a bit different than diversifying your existing holdings. If a country’s reserves are growing faster enough, their dollar holdings can go up even as the share of dollars in their overall portfolio goes down. I suspect that is what happened with Russia last year, for example.

The other big question, of course, is how much additional pressure this all places on China: the Bretton Woods 2 system of central bank financing of the US current account deficit increasingly hinges on the People’s Bank of China’s willingness to keep adding to its dollar reserves at an accelerating rate.

The more other central banks shift out of the dollar, the weaker the dollar -- and the weaker the renminbi. And the weaker the renminbi, the more reason to bet on its eventual revaluation ...

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