Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Posts Tagged ‘US Treasuries’

Shift Reserves Away from US Treasuries

Posted by butalidnl on 8 August 2011

The Bangko Sentral ng Pilipinas (BSP) has said that it was considering shifting some of the Philippines’ Gross International Reserves (GIR) from US Treasuries. I think it should. It is high time that the Philippines stops relying on the US dollar as the sole reservoir for our hard-earned money.

Liquidity
HSBC objects to the BSP plan, and advises the BSP to stick to using US Treasuries exclusively. It says that US Treasuries are the most liquid. But the question that we should ask is: How liquid should the Philippines’ reserves be? If we shift from US Treasuries to German bonds, will we then be holding instruments that we can’t sell right away? I doubt that – German, Dutch, Norwegen, Australian bonds (which all have AAA status, unlike US Treasuries) are liquid enough. We can sell them in a matter of days and at a good price – there are enough of those bonds going around for that. Perhaps not ‘instantaneously” like US Treasuries. But we don’t need instruments to be THAT liquid.

One other thing about liquidity is that it is a function of how much a country borrows. Because the US, Japan and Italy are the world’s biggest borrowers, that is why their bonds are the most plentiful, and thus the most liquid. But they are not necessarily the best places to put our money.

Reserve Value
Reserves should be able to keep their value with time, or even appreciate.  It would be prudent, even imperative, to keep our money out of instruments that we expect to lose value.

US Treasuries, like all bonds,  lose value as their interest rates rise. Now, the interest rate on Treasuries are at a very low point – 10 Year Treasuries are at 2.3%.  If the interest rate were to rise – as it should – the Philippines would lose money holding them.

And then we also need to consider the deteriorating value of the US Dollar. The Philippine peso is now trading at 42:1 to the dollar. A couple of years ago, it was 44:1.  We lose money by keeping dollars in our reserves. But if we had stored the reserves in Yen or in Euro, the value would have remained the same (in terms of pesos) or even appreciated.  The dollar is bound to lose value in the future, and we would be throwing away our money if we were to put all of our reserves into it.

Major Trading Partners
One of the principles in keeping international reserves is to keep them roughly based on a country’s trading partners.  On this basis, the Philippines should indeed diversify away from US treasuries.  If we look at the Philippines’ trading partners for 2010 we can see that China is our number one trading partner (17.3%), followed by Japan at 14.6% of trade. The US is only our third trading partner, at 12.3%.   Based on this, it would be logical to keep more Yuan and Yen in our reserves than dollars.

The Department of Finance seems to be saying that it has diversified our Gross International Reserves away from US dollars. But they do not say what percentage of the GIR remains in US Treasuries. If they truly have diversified, the GIR should be less than 50% in US dollars by now.

Posted in peso-dollar rate, Philippine economics, Philippine politics, Philippines, World Affairs | Tagged: , , , , , , , , | Leave a Comment »

Is US Dollar About to Fall?

Posted by butalidnl on 19 May 2011

The US Congress will have to raise the Debt Ceiling from the present $14.3 trillion by August 2, or else the country would face technical default. But the Republicans are demanding budget cuts be done first; and Democrats are demanding that measures should include increased taxes for corporations and the rich. Both sides are standing their ground, and there is a real danger that the country will indeed default by August 2.

Most probably, a deal will be made at the last minute, and the US can go on merrily increasing its national debt for a few more years. But the question remains: can the US dollar’s credibility withstand such a strain? Will the US dollar fall while Congress debates over raising the Debt Ceiling?

I think that sooner or later, within the next 5 years or so, the US dollar is going to “fall”.  The national debt limit is only part of the problem; the main problem is that the US has a triple deficit – of the budget, trade balance, and payments. And that it has accumulated a huge amount of “unbacked liabilities” in the world – to the staggering amount of $75 trillion.

All proposals on the table will help to reduce the budget deficit, but it will even not be enough to get a balanced budget.  Since there will continue to be a deficit in the coming years, the national debt will continue to grow. And then, there is the trade deficit which also grows from year to year. Thus, all plans now being considered will not improve the US’ capacity to repay its debt.

The world is getting impatient with the dollar, and it seems that US politicians are taking their time at solving it, not realizing that the problem is really urgent.

Signs of Trouble
The problems in the Middle East are all in the news. But the biggest problem with it lies not in Libya or even Yemen – but in the fact that the US dollar has not strengthened in the face of all these problems. Almost always before, when there is political turmoil somewhere, the US dollar gains in value, as money exits that country and goes to the safety of the US dollar. Now, the whole Middle East is ablaze, and the dollar, instead of strengthening, has weakened considerably.

Another sign of impending trouble is that the US, even with “QE2” (the program of the Fed for creating $ 600 B by buying government treasuries) and the extremely low Fed interest rate, faces rising commercial interest rates. QE2 was instituted in the first place to REDUCE interest rates. What will happen after June, when the QE2 program is over? Will interest rates rise substantially, resulting in a rise in unemployment? Will there be a double dip recession? If the Fed makes a “QE3” program instead, will this be enough to hold interest rates down? or will foreign fund managers dump US treasuries instead?

A third sign of trouble is the news that PIMCO, the world’s biggest holder of bonds, has entirely stepped out of US Treasuries. Even worse, PIMCO has resorted to selling US Treasuries short – which means that it even has negative ownership of Treasuries. This shows that US Treasuries are no longer attractive to the wiser international investors. I doubt that many hedge funds keep Treasuries in their portfolios either.

A fourth sign is that when Osama bin Laden was killed, he had with him 500 Euros. He had Euros, not US Dollars, which means that he considered Euros more useful in case he had to escape capture in Pakistan – Euros seem to be more useful in bribes etc. in Pakistan. This shows that even in the underworld, the US dollar is not considered a good currency anymore.

Roots of Crisis
The present crisis has its roots way back in the Bretton Woods agreement, made after the Second World War, to have the US dollar as the world’s reserve currency. Until 1971 the dollar’s value was pegged to the US supply of gold, keeping the US currency in “control”. In 1971 President Nixon let loose the gold peg, making the dollar itself as the only thing in reserve.

The US dollar as reserve currency meant that countries were willing to run a trade and exchange imbalance with the US, since this would mean that they would accumulate US dollars in their reserves. This meant that the US tended to have a structural trade and payments deficit with the rest of the world. This  effectively overvalued the dollar, making its imports cheaper than they otherwise should be. And this contributed to the very high standard of living in the US.

Over the decades, the US steadily accumulated a big debt burden. It is now at $14 trillion, or more than 90% of the US’ annual GDP. Among developed countries, it is only Greece and Japan which have higher debt/GDP ratios. Greece has had its debt crisis, and is now forced to undergo a strict program to get rid of its deficit. As for Japan, most of its debt is to Japanese citizens – and thus the impact of the debt is less than if it was held by foreigners.

The US debt is only part of the “US dollar overhang” in the world economic system; because the bigger part (approximately $60 trillion)  is simply the dollar reserves that countries have accumulated, due to the US trade deficit.  The national debt, in the form of US Treasury Bills, is the smaller part of the problem; but it is the more worrisome part of it, since the US has to pay interest on this.

Stumbling into Dollar Fall
The danger is always present that a country would decide to dump their US treasuries, leading to a chain reaction that sees other countries dumping treasuries, a spectacular rise in interest rates, and the dumping of US dollars from national reserves, and the fall of the dollar. This has not happened so far, since no country will do that consciously and devalue their own reserves. But we cannot depend on this not happening in the future. In fact, I think that the chance of this happening is getting bigger with time.

As more and more dollars are sent abroad, in the form of  US Treasury bills or simply “cash”, the danger that they will no longer be accepted by other countries increases. Already, many countries are calling for an overhaul of the international currency system. Countries have to continuously weigh the advantages of holding dollars against the cost due to the continued watering down of the dollar’s value.

Even if no country would willingly cause the dollar to fall by dumping it, a series of smaller events could push things so that even  minor players could accidentally cause such a fall.  The recent intervention against the Japanese Yen had the inadvertent effect of increasing Central Banks’ reserves of dollars. Central Banks all over the world had to subsequently find ways of restoring their dollar reserves to normal levels. The BRICS agreement to use their own currencies when trading with each other means that less dollars need to be kept as reserves. Eurozone countries intervention to support weaker Euro countries’ finances is another measure that strengthens the euro against a potential fall of the dollar. All these make the dollar weaker. A disruption of the scale of the 2007 sub-prime crisis happening now would surely topple the dollar.

Perhaps it won’t even be a single country or investor which would precipitate the dollar’s fall. It could be simply an accumulation of small steps that would push it over the edge. The US high unemployment rate has “forced” the Fed to keep the Fed Funds rate low, but this at the same time increases consumption and imports, and to further trade deficits.

The US dollar is undergoing something like a game of international “musical chairs”. US-based investors buy securities in other countries, effectively moving dollars abroad; Central Banks sell dollars to prevent their currencies from appreciating; the continuing US budget deficit means that the government has to issue more Treasuries;  foreigners buying US equities or Treasuries effectively returns dollars to the US;  too much incoming dollars could cause inflation, and increase unemployment. The cycle continues, and dollars are passed back and forth from the US and abroad.  A growing number of Central Banks are wary of keeping too much dollars, and this cycle would eventually break down at some point.

Tipping Points
There are a number of occasions or events which could push the dollar over the edge. The Debt Ceiling of the US has been reached, and by August 2 the US Congress has to agree to raise the limit. Not to do so will surely bring about a loss of trust in the dollar, and its subsequent fall.

And then will come the budget discussions later in the year. This is another occasion when confidence in the dollar may be critically damaged.  This will be followed by the Presidential election campaign and possibly a new administration.

At any time, Congress may pass a law imposing a tax on Chinese imports. This will cause Chinese countermeasures, including a stop to buying US Treasuries. And this will be enough to precipitate a chain reaction that will cause the fall of the US dollar.

The US dollar will fall within the next 5 years. While it will cause a deep crisis, it won’t be that bad, in the long run. I wrote a blog post about how it will be Two Years After the Dollar Fall

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Two Years After the Fall

Posted by butalidnl on 10 March 2011

It is now March 13, 2014. America has undergone a huge shift in its economy in the last two years. On this day, in 2012, the dollar “fell” in value, by about 100%; and more importantly, it “fell” from its position as the world’s reserve economy.

The Dollar Falls
It all started in November 2011. Riots had broken out in Saudi Arabia, and the government was frantically trying to restore order. The Saudi government had bungled in its handling of a relatively small disturbance among Saudi Shiites in Qatif, in the Eastern province. In November 2011, the disturbance had escalated into a nationwide protest movement. By December, workers in the vital oil industry and in the ports had gone on strike. And the demands had hardened – where before they had merely asked for the release of arrested Shiite leaders, protesters had now gone on to demanding a Constitutional Monarchy, some even wanted a republic, while others were calling for the independence of the Eastern province. All of this caused the price of oil to go through the roof. By the end of December,  oil had reached $200/barrel.

To make matters worse, the US response to it was also wrong. Congress passed a new Stimulus Bill of $500 billion, and the Fed proclaimed QE4 – a program to pump $1 trillion into the economy, as a response to the new recession. Unlike what happened during the 2008 recession, however, the US was now alone in pursuing an expansionary policy. This caused a lot of misgivings in other countries regarding the value of the US dollar.

Oil producing countries responded by demanding that they be paid in “hard” currencies – e.g. Euro, Yen, even the Chinese Yuan – and NOT in US Dollars. By January 2012, Central Banks all over the world decided to cut the US dollar component of their reserves, by a modest 1/4. Thus, from an average of 80% of reserves in US dollars, to 60%. This seems to be a modest change in policy; but when it is done by ALL Central Banks at the same time, it had a devastating effect. This policy meant that the Central Banks would gradually replace their dollars with other currencies in the course of a number of months, eventually ending with the target percentage of US dollars in reserve. By the end of February, however, the value of the US Dollar had gone down to the point where Central Banks holding lots of dollars (mostly in the form of US Treasury Notes) became nervous. They stood to lose a lot, if the dollar lost value.

So, it finally came on Tuesday, March 13, 2012. The Saudis were the first to dump their US dollar holdings. This was followed by Russia, Japan, and then China. After this, everybody else dumped their dollar holdings. You could probably speak of an “oversold” situation with the dollar then, but Central Bankers didn’t care anymore – they just wanted out, as quickly as possible.  As a result of all this, the dollar sunk to $4: 1 Euro on March 16, 2012. In the months following, the dollar regained some strength, finally stabilizing at $3:1Euro by December 2012.

Picking up the Pieces
The US was left to pick up the pieces. It still had a big budget deficit, and a huge payments deficit, and a 16 trillion national debt. The only good news in all this was that the national debt remained at 16 trillion dollars, even though the dollar was half its former value (thus, effectively the national debt was reduced by half).

The US had to go to the IMF to borrow money to finance its budget deficit. Nobody else was willing to lend the US money at that time. The US got a 500 billion SDR loan from the IMF (roughly equivalent to $500 billion at the old exchange rate). But the IMF loan came at a price: the US government had to cut spending, and increase taxes, and it had to have a concrete program to balance the budget by 2015. The US also had to open up its economy to foreign investments (thus, the airline, oil, banking etc. industries were opened to 100% foreign ownership).

Recovery
The IMF conditions were tough, but now, 2 years after the fall, the economy is on its way to recovery. US labor costs had dropped in relation to the rest of the world (while the US dollar’s value was halved, prices rose 30% and wages rose only 10%). This has led to a huge expansion in US-based manufacturing of products which used to be imported from China. (Another large chunk of the production had gone to Mexico, from which it is cheaper to ship to the US.) Automobile production has greatly expanded, with so many people buying smaller cars, hybrids and EVs (Electric Vehicles). And there is now a huge demand for buses, as local governments expand their public transportation services.

Tourism is now booming, with Asians and Europeans making the most of  “cheap” US vacations – tourism revenues have quadrupled since 2012. There is also a surge of “medical tourism”, with Europeans and Asians coming for elective surgery (which are not covered by their country’s health insurance).

American university enrollment has surged; while the number of American students has lessened, foreign students have more than made up the loss. Foreigners find that the US is offering quality education at bargain prices. And while foreign graduates are now in demand in the US, a bigger percentage of them opt to work in their home countries about graduation.

The stock market is enjoying a bull market of sorts – the Dow Jones just topped 20,000 points last January. Some companies are having a hard time: Walmart’s sales suffered as a result both of the lower purchasing capacity of people and the higher prices of goods. It is now repositioning stores to city centers, since people now find their suburban locations “too far away” (due to high gasoline costs). Starbucks has suffered because people have decided en masse that Starbuck’s coffee is a “luxury that they could live without”. Airlines are suffering from people cutting back on air travel.

But more companies are thriving: McDonalds has noted an increase in sales, even in the face of 30% higher prices; Amazon has seen a boom in the sale of Kindles and e-books (paper prices have also spiked); IT companies are profiting from people spending more time at home (people are also working more from home).

People have developed new habits. The magnetron is still all important; what’s new is that companies are now selling magnetron meals in reusable containers. Children often go to school now on bikes (leading to a reduction in child obesity). People are consuming more (local) vegetables, and eating less meat.

Many more people are employed than at any time in the past few decades. The unemployment rate is now at 5%, and is still dropping. There are less illegal Latinos now, since many Mexicans now prefer to work in the new Mexican factories. Americans are now more willing to take on farm jobs that were formerly done by Latino migrants. There is a marked reduction in the drug trade, with lower US buying power and prosperous Mexican workers.

There are now plans to build a nationwide rapid rail network. Ordinary rail lines are more intensively used for carrying products (replacing trucks), and a lot more products are transported by water. Solar farms are being set up in the Southwest; in Hawaii, the government is feverishly building solar and wind power plants (Hawaii was the worst hit by the oil price rise).

The “fall” of the dollar has caused a lot of suffering in America. But the American people are not only adapting well to the change, they are actually thriving. The resilience and hard work of the American people is now showing that a new economy could be fairer, greener, more equal, and eventually, more prosperous.

Some people say that the “fall” may have been the best thing to happen to America. They’re probably right. The future indeed looks quite bright.

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