Dollar Drops as China to Diversify Holdings

MoneyNews ^ | November 10, 2006

[GodGunsGuts]

Dollar Drops as China to Diversify Holdings

MoneyNews Friday, Nov. 10, 2006

LONDON -- The dollar sank to a two-month low on Friday after further comments from China's central bank governor Zhou Xiaochuan on the bank's plans to diversify its $1 trillion in currency reserves, while European and Asia shares fell amid soft economic data.

Already under pressure after a weak reading of U.S. consumer sentiment, the dollar extended Thursday's losses after Zhou said China had a clear plan to diversify its FX reserves.

Zhou, speaking at a meeting of central bankers in Frankfurt, said diversification would include different currencies and investment instruments. Although Zhou said there was no change to China's long-standing diversification policy, many traders took his comments to mean China might buy fewer dollars as the country's massive current account surpluses swells its coffers.

"Undoubtedly, the dollar has weakened on the comments. But on the basis of the comments in and of themselves, I wouldn't expect the dollar to continue weakening," said Todd Elmer, currency strategist at Citigroup.

"I'd expect the trend of reserve diversification to be unfavourable for the dollar over time, but we have to be cautious. I'm not sure this rhetoric means you should chase the dollar weakness, but I wouldn't expect significant dollar rebound in the near term," Elmer said, citing interest rate differentials in the coming weeks that are unlikely to be dollar-positive.

The dollar hit its lowest level in more than two months against a basket of major currencies and touched a 2-1/2 month low against the euro at $1.29 per euro.

The dollar and other currencies also came under pressure against the yen overnight after Bank of Japan Governor Toshihiko Fukui said he was concerned about a sharp unwinding of carry trades in which investors borrow the low-yielding Japanese currency and buy higher yielding currencies.

The dollar was buying 117.35 yen.

SHARES DIP

The FTSEurofirst 300 was down 0.1 percent at 1,465.3 points, off Thursday's 5-1/2 year high as weakness in pharmaceutical stocks in particular weighed.

Concerns that drug companies may eventually face price controls from the U.S. government have arisen since Democrats won both the House of Representatives and the Senate in U.S. mid-term elections.

"The view is that for the next little while, that will be a headwind to drug companies in the U.S. It's a sentiment thing," said Stephen Dowds, head of international equities at Northern Trust.

AstraZeneca was down 2.2 percent and rival GlaxoSmithKline fell 1.7 percent.

However, equity markets overall looked attractive, with solid growth and reasonable company earnings, Dowds said.

"Corporate balance sheets are very strong, people are looking for growth and there's a lot of cash sitting on the sidelines in either private equity hands or even in quoted companies' balance sheets."

Data showing the French economy unexpectedly stagnated in the third quarter did equities few favours, while weaker-than-expected machinery orders in Japan helped push the Nikkei to a one-month closing low of 16,112.4 points.

EURO ZONE BONDS FIRM

The prospect of China diversifying further out of dollar denominated assets proved a boost for European government bonds on hopes they might attract more Chinese buying, but analysts noted it was a gradual process.

"It's been an issue for months. We are certainly seeing some diversification into euro zone bonds, but I don't think it's on as big a scale as many people think," said ING's Padhraic Garvey.

The December Bund future rallied to test key resistance at 118.00, up 18 ticks, while the 10-year note was yielding 3.718 percent.

Gold edged up as the dollar weakened and as investors speculated China would diversify into bullion or other commodities.

Zhou said diversification included currencies and investment instruments including emerging markets but asked if this included gold, he said: "That's a separate thing."

Spot gold was trading around $634 an ounce, having touched a two-month peak around $636.50.

Oil prices retreated, giving up most of Thursday's gains as traders booked profits. The International Energy Agency (IEA) noted that inventories in OECD nations had risen at a rate of 1.15 million barrels per day during the third-quarter, the highest third-quarter build in 15 years, but also predicted a jump in demand during the current quarter.

U.S. light crude was down 72 cents at $60.44 a barrel.

[headsonpikes]

Gartman makes some interesting observations this morning about the Chinese banking/money system, esp. re the consequences of liberalizing - capital flow out!

I'll post a couple of excerpts:

"Flying back from London on Friday we had
the time to consider why it was that the People's Bank of
Chinas has been so uncommonly aggressive in moving to
raise its discount rate in recent months. As we have said,
open market operations normally are feather-weights when it
comes to changing monetary policy. Repos and "reverses"
add or subtract money from the banking system at the
periphery and only then in very modest amounts. Thus when
the Fed does a repo, or when the PBOC does the same, the
effect is modest... almost imperceptible. However, we have
learned the very hard way that when a central bank moves to
change its reserve requirements it is almost always a large
cudgel aimed at the very forehead of the economy.... a
virtual 2x4 taken to the head of the economic donkey as it
were to make certain that the master has the donkey's
unmitigated attention. Usually it works; indeed, almost
always it works too well, for when reserve requirements are
raised, money is drained massively and permanently from
the system, and share prices first collapse and then the
economy follows.
Why then has the stock market in China not plunged and
when they has the economy there continued to rush higher,
despite a second reserve requirement increase? Perhaps
the reserve requirement increases were not done with the
purpose of slowing the economy or of pushing share prices
lower? Perhaps there is something more at work here than
we thought reasonable? Perhaps the forex market can
explain what is happening? ....

....Given that Beijing
works under a "controlled rate" foreign exchange regime
rather than a floating one, the authorities have no choice but
to issue Yuan to buy all of the foreign exchange offered to it
from the trade surplus. In the process, the monetary
authorities are by definition exploding the money supply in
China. There is nothing else they can do so long as the
"controlled rate" regime is held intact. In the process, the
nation's banks (horrid though they may be when compared
to the loan losses and reserves that the banks in the West
would find reasonable) are flush with cash that must be put
to work, and they put it to work via loans, equity purchases,
debt purchases, etc.
The authorities keep telling the banks to slow down their
lending, but the banks cannot help themselves. Even as
they might wish to follow Beijing's pleading to slow lending,
the wall of cash coming at them from the authorities
themselves make the job of slowing lending almost
impossible.
Thus, the only weapon left to the monetary authorities in
China is to raise the reserve requirement. If money has no
choice but to be injected into the banking system because of
the trade surpluses that China presently enjoys, and if the
authorities are going to hold to the "controlled" foreign
currency regime for a while longer, there is nothing else that
can be done. The system begets itself, and more reserve
requirement increases lie directly ahead.
Finally, the whole problem could be avoided if the Chinese
were to immediately move to a floating rate regime that did
not mandate that the authorities buy the currencies that are
brought into the country via exports. This is the best reason
for China to push as swiftly as it can toward a free float and
way from the managed, controlled one it is now operating
under. ...Oh, and there is always this to remember: If China were to
move to a freely floated currency, the US might find itself
embarrassed by the fact that rather than a currency that
strengthens immediately and lastingly, instead we might well
find that the Renminbi collapses as capital that has been
locked up in China for years with no real avenue of escape
moves out and away in violent fashion. Capitalists who've
made millions upon millions of dollars in China in the past
decade or so shall very reasonably want to diversify their
assets abroad, away from the control of Beijing authorities.
Certainly we would were we in that position, and certainly
shall hundreds upon thousands of newly minted Chinese
millionaires. As always one must be careful what one asks
for, 'cause you just might get it... good and hard, as H.L.
Mencken so wisely taught us decades ago."

Very intriguing.

[GodGunsGuts]

No gold bugs that I know of want to see a collapse of the dollar. They are buying gold because they think that America has got itself into an economic pickle that necessitates a dollar decline. But they would much rather see the American economy flourish (as opposed to being driven along by debt) and gold go down than the opposite. That's certainly my perspective.

[GodGunsGuts]

Very intriguing indeed. Thanks for the post--GGG

[GodGunsGuts]

I'm all for the invisible hand when it comes to free countries trading with free countries. But I am not for trading with Communist dictatorships who use slave labor to erase any possibility of comparative advantage. They are using us and we are using them. And as someone else said on this thread (maybe you?) we have become so intertwined that we have formed a defacto partnership. No non-Communist government has ever formed a partnership with the Communists and managed to come out on top. Look at what happened during Lenin's NEP. Look at what happened with regard to the lend-lease program and our partnership with Uncle Joe (in which the Soviets went on to topple China, then N. Korea, Vietnam, etc.). Even now, the coalition government that was formed in Nicaragua is being torn asunder and the Communists are emerging the victors. The list goes on and on. One of the phrases of the Reagan Revolution was "No Aid and Trade with Communists." That slogan is just a valid today as it was then IMO.

[GodGunsGuts]

Actually, I'm not so sure that he does. He's all for free trade with Communist dictatorships such as Red China.

[RinaseaofDs]

I have a simplistic question:

Where are they going to go? The Euro?

I can see going to the Yen, but beyond that, where?

[pfony1]

Forgive me if I take your comment with a TON of salt.

IMHO, doom-sayers are NOT "hopeful" people. What I see instead here is a person, who:

(1) has over-invested in "gold" ("shares", mind you, LOL!) and
(2) therefore, needs the price of gold to rise to avoid a loss, and
(3) therefore, needs to encourage others to buy gold and
(4) therefore, tries (unsuccessfully, IMHO) to induce undue panic regarding "fiat" currency in anyone who will listen.

I hope you can see that this series of actions is fundamentally dishonest.

Saaaayyy...

Is your day job: "used-car salesman"?

[Toddsterpatriot]

Gold, GOLD, GOLD!!

[GodGunsGuts]

Sorry to burst your bubble, but I have already made a respectable profit for the year. And speaking of dishonest, why do you keep shilling for the Communist Chinese???

[GodGunsGuts]

They already said they will be diversifying into the Euro, Yen and a number of other currencies. And as Toddler already mentioned, they will also be adding to their gold reserves.

[remember]

I just noticed that the very same year that was supposed to be so wonderful for the middle class as far as getting an even share, just happened to be the same year that middle class real income was at a record low!

That's why in terms of actual income, '79 was a disaster for the middle class.  After all, those were times of double-digit unemployment and inflation  --Carter's malaise daze! Of course, they had an equal share --of nothing!

Could you please provide a source for the numbers in your graph and your comment about real income in 1979? They appear to be very much in conflict with recent data from the U.S Census Bureau. For example, the following graph shows Mean Household Income Received by Each Fifth in 2005 CPI-U-RS adjusted dollars as given on the Census Bureau site at http://www.census.gov/hhes/www/income/histinc/h03ar.html:

The actual numbers and sources are at http://home.att.net/~rdavis2/income.html. As can be seen, mean income received by the middle quintile of households was at at a then-record HIGH in 1979, not a record LOW. It had increased from a low in 1975 and slumped again in 1982. Also, your graph appears to show income increasing through about 2002 or 2003 whereas the census data shows income dropping from 2000 through 2004. Finally, your graph shows income going from about $45 thousand in 1967 to about $54 thousand in 2003. The census data, however, shows it going from about $35 thousand to $46 thousand during that period. In fact, I noticed in the table at http://www.census.gov/hhes/www/income/histinc/h01ar.html that even the upper limit of the middle quintile was $41 thousand in 1967 (in 2005 dollars), below what your graph appears to show. Anyhow, a source would be appreciated. Thanks.

[GodGunsGuts]

This should be interesting. Thanks for the post.

[expat_panama]

Nice to have you on board Rem --as a matter of fact I was just trying to find out where I got those numbers myself when you came in.  Your post 171 included middle class household income stats that back up my point that the middle class is much better off than is was in '67.  That's fine with me, but not with Guns.  His iTulip.com chart seems to be using family income figures going back to '47, like maybe http://www.census.gov/hhes/www/income/histinc/f01ar.html but that shows just an upper limit and not mean income.  

You need to be brought up to speed here first.  We were talking about whether Chinese trade has hurt the US, I said America's richer, and Guns says only some Americans are while most are poorer.   More detail:

Dollar Drops as China to Diversify Holdings  -thread started by GodGunsGuts focus on trade and exchange rate with China.

5  by snarks_when_bored "we allowed the Chinese to start building lots of essential stuff for us, but we've also allowed them to lend us the money to buy the essential stuff"

 56 by expat_panama  "... Chinese 'loaned' us Americans $200 billion ...  ... in the same year the total private wealth in the US increased by $5,200 billion. ...don't see how this is supposed to be the end"

57 by College Repub "wealth that was created was not distributed in the same manner"

61  by expat_panama "you just made it all up"

67 by GodGunsGuts  [iTulip.com graph] 

71 by GodGunsGuts  If the middle class is shrinking..

75 by expat_panama  "of numbers that show that the middle class is earning more money than ever before,"

82 by GodGunsGuts  "If the graph is true..."

No problem.  Guns hasn't been able to find out if the iTulip chart is true, but he's worried about it anyway.  My take is that the chart's numbers are in fact more or less right, but they still don't prove that anything is bad.  

We don't want to keep going all over the place here; we need to focus.  Sure, I'd love to talk about whether '79 was a prosperous era or not, and maybe you and guns can post a vanity titled "1979 - a Wonderful Year for America's Middle Class".  I'd really rather go to a different thread instead of hijacking this one  --we can save this one for taking on the question of whether or not America's been badly hurt by Chinese trade.

[remember]

Nice to have you on board Rem --as a matter of fact I was just trying to find out where I got those numbers myself when you came in. Your post 171 included middle class household income stats that back up my point that the middle class is much better off than is was in '67. That's fine with me, but not with Guns. His iTulip.com chart seems to be using family income figures going back to '47, like maybe http://www.census.gov/hhes/www/income/histinc/f01ar.html but that shows just an upper limit and not mean income.

Thanks. The following table shows the 1979 to 2001 increases as calculated using data from http://www.census.gov/hhes/www/income/histinc/f03ar.html:

   Mean Income Received by Each Fifth and Top 5 Percent of
            Families, All Races (in 2005 Dollars)

             Lowest  Second   Third  Fourth  Highest    Top 5
      Year    fifth   fifth   fifth   fifth    fifth  percent
----------  -------  ------  ------  ------  -------  -------
      1979    14945   32312   48730   67088   115070   170331
      2001    15462   35803   56836   84525   176054   309126
----------  -------  ------  ------  ------  -------  -------
% Increase     3.46   10.80   16.63   25.99    53.00    81.49

Hence, the red bars in the iTulip.com chart appear to be correct, at least according to that Census table. However, I don't know where the 1947 figures came from.

Regarding the graph that I posted in my prior message, it does make it appear that the middle class is better off than it was in 1967. From looking at a number of income statistics, however, I find that you need to be very careful not to overinterpret any one statistic. For example, the following graph contains additional data from the Census Bureau:

The actual numbers and sources are at http://home.att.net/~rdavis2/ftyrinc.html. According to this data, the real median income of full-time, year-round male workers has pretty much stagnated since 1973. The increase in the real median income of full-time, year-round female workers may have something to do with the increase in household income since 1967. However, another factor may be that more women have entered the workforce giving many households more wage-earners than before. In any case, the fact that the median income of male workers appears to have stagnated for over 30 years would seem to merit some additional study.

To further confuse the issue, the following graph shows "Total Private Average Weekly Earnings, 1982 Dollars - Seasonally Adjusted" from the Bureau of Labor Statistics:

The actual numbers and sources are at http://home.att.net/~rdavis2/jobs.html. According to this data, there appears to have been a huge drop in real average weekly earnings from 1973 to 1991 and a recovery of just about a third of that drop from 1996 to 2004. I'm unclear as to why this huge drop does not show up in the prior graph. All that I can think of is that they are not measuring the exact same population of workers or that those workers have worked a varying number of weeks per year. In any case, the large drop in real weekly earnings would seem to once again merit additional study (and arguably some concern).

Your numbers add one more layer of confusion. They may have come from a bad source or they may be making a different measurement of yet another slightly different population. If you do find the source, please post it. Until then, I'll just have to go with the numbers that I posted from the Census Bureau site.

[expat_panama]

This should be interesting....

  ...the middle class is better off than it was in 1967

At least we've figured out that the middle class hasn't shrunk.

[expat_panama]

Your numbers add one more layer of confusion. ... I'll just have to go with the numbers that I posted from the Census Bureau site.   ...the middle class is better off than it was in 1967

Our question was who's been getting how much money, so our job was to decide who is 'who', and what is 'money'.   In other words, who it is we're talking about (households? families? wage earners? per capita?), and what is income (is it wages? all income? the change of net-worth? before or after taxes? monthly or annually?).  

This is great for political arguments because we can pick and choose some specific combination to "prove" that America was better or worse off which ever year we want.  On the other hand, if we're trying to know what's actually going on (say, for running a business), then it means we have to work harder.  My take is that those census numbers you mentioned were intended for politics, because they just don't add up.  The 2005 total of all the average quintile incomes was $317 billion, but the BEA says that Americans earned two or three times that much:

Table 2.1. Personal Income and Its Disposition [Billions of dollars]	2005
Personal income	10,239.2
Compensation of employees, received	7,030.3
Wage and salary disbursements	5,664.8
Private industries	4,687.1
Government	977.7
Supplements to wages and salaries	1,365.5
Employer contributions for employee pension and insurance funds	933.2
Employer contributions for government social insurance	432.3
Proprietors' income with inventory valuation and capital consumption adjustments	970.7
Farm	30.2
Nonfarm	940.4
Rental income of persons with capital consumption adjustment	72.8
Personal income receipts on assets	1,519.4
Personal interest income	945.0
Personal dividend income	574.4
Personal current transfer receipts	1,526.6
Government social benefits to persons	1,480.9
Old-age, survivors, disability, and health insurance benefits	844.9
Government unemployment insurance benefits	31.3
Veterans benefits	36.8
Family assistance \1\	18.3
Other	549.4
Other current transfer receipts, from business(net)	45.7
Less: Contributions for government social insurance	880.6
Less: Personal current taxes	1,203.1
Equals: Disposable personal income	9,036.1

When I'm interested in actually knowing what's going on, I take the percents from the Census Br. and multiply them by one of the BEA's numbers.  I still have use rubber gloves and wear a gas mask, but at least the numbers add up.

[unixfox]

When they decide the bill is due and payable, ...

They won't want our worthless paper money, they will want our gold.

[Toddsterpatriot]

They won't want our worthless paper money, they will want our gold.

Unfortunately for them, dollar denominated debt is only redeemable in dollars.

[expat_panama]

Aw hell Todd,

Here they had it all figured out how everything was bad, and then you had to just go and ruin everything with good news.

[Toddsterpatriot]

and then you had to just go and ruin everything with good news.

Yeah, the truth doesn't always hurt.