The Currency Manipulation Follies, Chapter Umpteen


Central Banks Weigh Up Dollar Problem

By Peter Garnham
Financial Times, London
Wednesday, November 21, 2007

The sliding dollar has presented custodians of the world's massive foreign exchange reserves with a conundrum.

Countries such as China and those in the Gulf, which peg their currencies to the dollar, risk inflationary pressure that has the potential to trigger serious economic and social problems.

But any move to cut their links to the dollar could spark a run on the currency that would undermine the value of their reserves.

Global currency reserves have soared from $2,000 billion in the second quarter of 2002 to $5,700 billion (E3,885 billion, L2,780 billion) in the corresponding period this year, according to the International Monetary Fund. Furthermore, two-thirds of the world's reserves are in the hands of six countries: China, Japan, Taiwan, South Korea, Russia, and Singapore.

But China tops the league, with the latest official figures showing the value of its reserves at $1,443.6 billion in July. Many of China's trading partners argue that this stockpile -- which grew at $40 billion-$50 billion a month in the first half of the year -- has been caused by what they believe to be an undervalued renminbi.

Most analysts say that the country's reserves have accumulated rapidly since July and that this explains the growing concern about the dollar expressed by Chinese officials.

Yesterday the dollar plunged to a record low of $1.4813 against the euro.

Beijing does not reveal the currency composition of its reserves. However, informed observers say the weightings of its various currencies roughly follow the latest figures from the International Monetary Fund.

Central banks which have revealed the make-up of their reserves hold on average 64.7 per cent in dollars, 25.5 per cent in euros, and the remainder in currencies such as sterling, yen and the Australian dollar.

China's concerns have been highlighted by Wen Jiabao, the premier, who said the country had never experienced such pressure over its reserves and that he was worried about how to preserve their value.

Hans Redeker at BNP Paribas says these comments are a clear indication that China wants to slow down the pace of increase of its reserves.

Primarily driven by food prices, China's rising rate of inflation currently stands at 6.5 per cent. Mr Redeker suggests that a rising renminbi is now favourable for the country as it will reduce import price pressure for food products.

"The undervalued renminbi supplied the globe with excess liquidity while the investment boom created demand for raw materials," he says. "This overvaluation [of raw materials] is now going to correct as China leads its currency closer to its fair value and tighter domestic conditions slow investment spending."

While an appreciation of the renminbi would slow China's accumulation of foreign exchange reserves, it would not address the problems caused by the weak dollar undermining their value.

Simon Derrick at Bank of New York Mellon says it is ironic that a large part of the reason for the dollar's fall can be attributed to central bank reserve managers.

IMF data reveal that, in the second quarter of 2002, the dollar represented 71 per cent of central bank holdings, while only 19.7 per cent was held in euros.

"All the available evidence indicates that the phenomenal growth in foreign exchange reserves over the past five years has been accompanied by a notable push to diversify away from the dollar and into the euro," he says. "This explains the rise of the euro."

However, other analysts were less sure of the role played by central bank reserve diversification in the dollar's fall.

They say cyclical factors are the main driver behind the dollar's 40 per cent drop against the euro since 2002, arguing that the shift in reserve currency allocations needed to drive the dollar so far would be much greater than the shifts reported by the IMF.

Marc Chandler, at Brown Brothers Harriman, says central banks may well be diversifying new reserve accumulation away from the dollar, but China's recent comments do not mean they are diversifying existing holdings. "What incentive do they have to tip their hand, even if that is what they intend to do?" he says.

In any case, Mr Chandler believes it is unlikely that the People's Bank of China has turned from the traditional role of a central bank to become a currency speculator.

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ECB Pressed to Curb Euro's Climb Against Dollar

From Agence France-Presse
via Yahoo News
Wednesday, November 21, 2007

FRANKFURT, Germany -- Europe's single currency is climbing quickly against the dollar and could seriously curb growth, forcing the European Central Bank to come up with a response, economists say.

The time for concern is over, the ECB must act, said Peter Bofinger, a top economic advisor to the German government in an interview posted by the German news weekly Der Spiegel on its website.

"We are acting like the evolution of currencies is a matter of destiny, an inevitable natural event," Bofinger said. "That is deplorable."

EADS chief Louis Gallois put it another way Monday, when he accused European leaders of "resignation" in the face of the euro's rise.

Most economic and political leaders have watched the euro's rise while voicing concern about the effect on eurozone exports that become more costly as the currency climbs.

Airbus, the European aircraft manufacturer that is owned by EADS, is on the front line, since it costs euros to produce the expensive airliners which are then sold in dollars.

This week, the euro broke through the level of 1.48 euros and appeared set to reach 1.50 as the US currency was hit by fears of an economic slowdown.

The United States faces more turmoil following the meltdown of the subprime market for high-risk mortgages, and the US Federal Reserve is expected to cut its main interest rate again next month to underpin economic activity.

Meanwhile, China's conversion of some of its massive foreign currency reserves into euros has put further pressure on the dollar.

Given the context, many question whether the ECB can intervene effectively on foreign exchange markets with massive dollar purchases to bring the euro down from its record heights.

"A unilateral intervention would probably have a significant short-term but no lasting impact on the exchange rate," Bank of America economist Holger Schmieding told AFP.

Since its creation in 1999, the ECB has never intervened "against" its own currency.

The bank, essentially the euro's guardian, bought the single currency in September and November 2000 however when it plunged in value against the dollar.

Four direct interventions, including one coordinated with the US Federal Reserve and Bank of Japan, had mixed success however, and the ECB now sees intervention as a last-ditch option.

In addition, interventions require support from other central banks to really be effective, whereas US officials appear ready to let the dollar slide, for now at least.

The ECB must therefore rely on verbal intervention, given that its other lever, the level at which it sets interest rates, is not a valid option at the moment.

If the bank lowered its interest rates to bring the euro down, it would fuel inflation that already exceeds the ECB's target of close to but below 2.0 percent.

ECB president Jean-Claude Trichet has therefore begun to express concern about the euro's volatile movements on foreign exchange markets, calling them "sharp and abrupt" early this month.

"Brutal moves are never welcome," Trichet added, using the same code word as in 2004 when he sought to limit the single currency's rise.

Schmieding suggested the ECB chief adopt a slightly different approach when the bank announces its next interest rate decision in early December.

"More dovish tones at the next press conference, for instance an explicit recognition that the strong euro poses a significant downside risk to growth, could have an impact," the analyst forecast.

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Japan's Trade Minister Says
110 Yen to the Dollar Is OK

From The Associated Press
via Yahoo News
Wednesday, November 21, 2007

SINGAPORE -- Japan's trade minister said Wednesday that an exchange rate of 110 yen to the U.S. dollar is appropriate and that further declines in the dollar to 100 yen over the next year would be too rapid.

"A yen exchange rate somewhere in the vicinity of 110 yen to the dollar should be an appropriate range," Minister of Economy, Trade, and Industry Akira Amari told Dow Jones Newswires during a visit to Singapore.

"It would be my personal sense that reaching 100 yen to the dollar within one year may be a little bit quick," he said.

The Finance Ministry, not Amari's trade ministry, controls Japan's currency policy.

The dollar fell to a two-year low of 108.89 yen Wednesday, the lowest since Sept. 5, 2005. It later rebounded to 109.21 yen at 4:50 p.m. Tokyo time (0750 GMT).

Amari said a stronger yen would erode profit margins among Japanese exporters but a gradual rise in the currency would not cause an excessive burden.

"A gradual appreciation of the yen reflecting the fundamentals of the Japanese economy would not have a negative effect," he said. "The worst that could happen ... is for exchange rates to go through wild fluctuations."