Central Banks Shun US Assets

Shifting reserves to eurozone will deepen Bush's difficulties in funding deficit Actions likely to undermine dollar's value further 

CHRIS GILES / Financial Times 24jan2004

Central banks are shifting reserves away from US assets and towards the eurozone in a move that looks set to deepen the Bush administration's difficulties in financing its ballooning cur-rent account deficit.

In actions likely to undermine the dollar's value on currency markets, 70 per cent of central bank reserve managers said they had increased their exposure to the euro over the past two years. The majority thought eurozone money and debt markets were as attractive a destination for investment as the US.

The findings emerge from a survey of central bank reserve managers published today and conducted between September and December of last year. About 65 central banks, controlling assets worth $1,700bn, took part and the results showed a marked change in attitude over the past two years.

Any rebalancing of central bank reserve portfolios has serious implications for the global financial system as the US has become increasingly dependent on official flows of funds to finance its current account deficit, estimated at $650bn in 2004.

At the end of 2003, central banks held 70 per cent of their official reserves in dollar-denominated assets and central bank purchases of US securities had financed more than 80 per cent of the the US current account deficit in 2003.

Any reluctance to increase exposure to dollar assets further could cause the greenback to plunge on currency markets.

"The US cannot take support for the dollar for granted," said Nick Carver, one of the authors of the study conducted by Central Banking Publications, a company that specialises in reporting on central banks.

"Central banks' enthusiasm for the dollar seem to be cooling off." In a further worrying sign for the greenback, 47 per cent of reserve managers surveyed said they expected the growth of official reserves to slow to less than 20 per cent over the next four years. Between the end of 2000 and mid-2004, official reserves had increased by 66 per cent.

Slower reserve accumulation growth implies the supply of official finance is likely to become more limited but few expect the demand from the US for finance to slow. The consensus among economists is that the US current account deficit will increase to $694bn in 2005.

More than 90 per cent of central bank reserve managers said that the income from reserve management was "Important" or "very important".

In the two years since a similar survey was conducted, reserve managers had begun to seek higher returns for the money under management.

For these managers, dollar assets have become less attractive because the fall in the dollar since 2002 has reduced the yield they received and, in some cases,has led to negative real returns. Alan Greenspan, the chairman of the Federal Reserve, warned in November that there was a limit to the willingness of foreign governments to finance the US cur-rent account deficit.

The survey was conducted on the guarantee of anonymity for the banks involved. The 65 central banks that participated control 45 per cent of global official reserves. Individually, they had up to $250bn under management.

The People's Bank of China and the Bank of Japan control larger official reserves than this so it is clear that they did not respond to the survey.

Dollar at the mercy of small group of central banks 

By Chris Giles, Economics Editor (p.2)

During the past few years the US has become dependent, not so much on mil-lions of investors around the globe, as on a few individuals in a few of the world's central banks.

In 2003, the most recent year with full international statistics, central banks financed 83 per cent of the US current account deficit, with Asian central banks accounting for 86 percent of flows. A similar picture is emerging for 2004. Despite a good start to the year, when the private sector was a large net purchaser of dollar assets, central banks came to the rescue again.

The People's Bank of China has let it be known that China increased dollar reserves by $207bn in 2004, financing nearly a third of the US current account deficit, estimated at $650bn.

Self-interest has supported much of this flow of cash.

The US has lapped up cheap finance to fund its appetite to spend. Asian governments have until now been keen to satisfy this appetite, in order to keep their currencies from appreciating. But all investors have their limits.

If new official flows to the US were to be curtailed, the dollar would plunge, creating a huge hole in the accounts of central banks holding dollars.

"The risk exposure for Asian central banks is already great," concluded Matthew Higgins and Thomas Klitgaard of the Federal Reserve Bank of New York in a recent paper. In November, Alan Green-span, US Federal Reserve chairman, suggested foreign investors would reach a limit in their desire to finance the US current account deficit and diversify into other currencies or demand higher US interest rates, "elevating the cost of financing" the deficit and "rendering it increasingly less tenable".

Until recently there had been little evidence to back up these fears but this has begun to change. Members of the Organisation of Petroleum Exporting Countries have cut the proportion of deposits held in dollars from 75 per cent to 61.5 per cent in the past three years.

The Bank of Thailand said this month it was considering reducing the proportion of its $50bn reserves held in dollars from 80 per cent to 50 per cent. Russian officials have made similar noises. A detailed survey published today suggests that central banks are increasingly moving official reserves out of the dollar and into the euro.

Asian central banks are unlikely to pull the plug on dollar assets. But they may be close to ending their willingness to provide cheap financing for the US current account deficit.