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April 2020
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Composition of world’s FX reserves

According to IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) database, US dollar remains the preferred reserve currency. In the fourth quarter of 2011, the dollar made up 62.1% of official reserves. The dollar accounted for 61.4% of official reserves in 2011 vs. 61.8% in 2010 and 62% in 2009.

See the chart below.

(graph courtesy of Northern Trust)


Euro = Failure

“You are all in denial. By any objective measure the euro is a failure. And who exactly is responsible, who is in charge out of all you lot? The answer is none of you because none of you have been elected; none of you have any democratic legitimacy for the roles you currently hold within this crisis.”



What’s Euro’s endgame?

Chris Wood shares his insights on what’s likely the endgame of European sovereign debt crisis.

He predicts it will be either a move from monetary union to fiscal union, or a complete breakdown of the Euro. He thinks the first scenario is more likely and Germany will eventually budge.


Then, Jim Rogers comes in with his thoughts:

Bridgewater’s Dalio on Investment Outlook

Ray Dalio, founder & CIO of Bridgewater Associates, runs the world’s largest hedge fund with $89 billion under management, returning more for the fund’s investors last year than Google, Amazon, Yahoo and eBay combined.

In this CNBC interview, Dalio shares his view on the US dollar, world investment outlook, the ongoing great deleveraging and the great divergence between the developed vs. developing world.

China-US: Frenemies – Battle in Rap

How much has Chinese Yuan really appreciated?

According to Economist Magazine, adding rising labor cost, Chinese Yuan has appreciated by nearly 50% against US dollar since 2005.

A real exchange rate takes account of price movements in each country. If prices rise faster in China than in America, China’s real exchange rate goes up, even if its nominal exchange rate stays the same. That’s because higher prices at home make China’s firms less competitive abroad, just as if their currency had gone up.To calculate the real exchange rate, you need a gauge of prices in each country. Many economists use the consumer-price index (CPI). But the CPI contains lots of goods and services (such as housing rents) that cannot be traded across borders.

Our measure of the real exchange rate, which we will regularly update, offers a more direct measure of competitiveness by looking instead at unit labour costs: the price of labour per widget. These costs go up when wages rise or productivity (widgets per worker) falls. In American manufacturing, unit labour costs have risen by less than 4% since the first quarter of 2005, according to the Bureau of Labour Statistics. In Chinese industry they have risen by 25% over that period, according to our sums.


Link to the analysis.

The Fed is set to surpass China…

The Fed is set to replace China as the largest holder of the US treasuries.

(source: Bloomberg)

Chinese government does not have much choice here.  It can’t ditch dollar – that’s the only international reserve currency today, probably the safest one in time of crisis;  It can’t buy gold, not much. Otherwise, it will push up gold price dramatically.  It can’t buy high-growth currencies, like Aussie dollar or Brazilian real, either:  the appreciation of these currencies will make China’s imports of natural resources more expensive.

Chinese central bank is left with roughly three choices:

1) buy assets denominated in Euro and Yen – Germans and Japanese then won’t be happy because now every country  seems to have adopted a “beggar-thy -neighbor” policy, trying to increase exports through currency devaluation.

2) buy hard assets, such as oil, gas and mines – that’s what China had been doing.  But this is likely to stir a lot of nationalism –   Nobody likes such government-led big purchase of its own natural resources, especially this government is led by a Communist Party.

3) equity investment in or partnership with good-solid companies.  Companies like Warren Buffet’s Berkshire Hathaway, Goldman Sachs, JP Morgan, Coca-cola, HP, etc…these solid blue chip companies with diversified international portfolio.

In the long term, China should work on designing an alternative international monetary system – a system not based on any paper currency of a single country.

A snapshot of global imbalances

Source: NYT

George Soros on Chinese currency

(click to play; source: FT)

Here is the related FT article:

The prevailing exchange rate system is lopsided. China has essentially pegged its currency to the dollar while most other currencies fluctuate more or less freely. China has a two-tier system in which the capital account is strictly controlled; most other currencies don’t distinguish between current and capital accounts. This makes the Chinese currency chronically undervalued and assures China of a persistent large trade surplus.

It is no exaggeration to say that since the financial crisis, China has been in the driver’s seat. Its currency moves have had a decisive influence on exchange rates. Earlier this year when the euro got into trouble, China adopted a wait-and-see policy. Its absence as a buyer contributed to the euro’s decline. When the euro hit 120 against the dollar China stepped in to preserve the euro as an international currency. Chinese buying reversed the euro’s decline.

Whether it realises it or not, China has emerged as a leader of the world. If it fails to live up to the responsibilities of leadership, the global currency system is liable to break down and take the global economy with it. Either way, the Chinese trade surplus is bound to shrink but it would be much better for China if that happened as a result of rising living standards rather than a global economic decline.

Why China wanted to peg US dollar?

Let’s put aside for now the debate on whether Chinese Yuan is undervalued or not,  what are the motives for China to fix its currency to the US dollar around 1995?

First comes to my mind is the need to remove currency risk in trade.  As we know, almost all trade contracts are denominated in dollar, not in Yuan.  Currencies tend to move a lot, and nobody likes volatility.  By pegging Yuan to the dollar, Chinese firms essentially save the cost from buying expensive currency risk hedging contracts.

Second, by fixing Yuan to the dollar, more or less, China submitted its monetary policy to the Fed, i.e.,  the Fed’s monetary policy tends to have a great impact on China’s own monetary policy. In other words, China’s central bank largely lost its autonomy.  Good thing or bad?

Below is a chart I just made looking at China’s domestic inflation, an important gauge for macro-stability, before and after the pegging to the US dollar.


(click on the graph to enlarge)

The chart is very dramatic.  Before 1995,  China’s inflation (in red) was very high and volatile.  The Great Inflation in 1988 partly contributed to the 1989 students’ demonstration, which eventually led to the unfortunate Tian’anmen incident.  After 1995, China’s inflation plummeted, and since then has remained quite stable – inflation never went up to over 10% again.

Was this because Chinese government suddenly improved their macro economy management skills?  I don’t think so.

Here is what really happened –  In essence, China achieved its macro-stability by outsourcing its monetary policy to the Fed, which has much more experiences in fighting inflation and also enjoys better credibility.

(update on Oct. 7, 2011)

A re-look at the interest rate changes during 1995-2005 between China and the US, I changed my view that China’s inflation decline was due to its pegging to the US dollar.  The more plausible explanation is China’s central bank successfully prevented inflation from rising by continuously raising interest rate, eventually pushing down inflation.