Dollar threat downgraded
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Emerging Markets

Dollar threat downgraded

Former US Treasury secretary says possible Iran reserves move is constrained

Former US Treasury secretary Larry Summers yesterday downplayed the danger of a run on the dollar resulting from Iran’s threat to diversify more of its foreign exchange reserves out of the US currency.

Countries planning to shift significant quantities of their external reserves out of the dollar might have difficulty “finding places with adequate liquidity” to absorb them, Summers told Emerging Markets

Iran’s central bank governor, Ebrahim Sheibany, had warned in an interview with Emerging Markets that Iran is moving closer to shifting reserves out of dollars as a result of the decision by the US Treasury to designate one of Iran’s largest banks, Bank Saderat, a channel of terrorist financing. Sheibany suggested that other countries could be influenced in their reserve policy by any such Iranian action.


Summers said that the scope for diversification of reserve assets out of dollars appeared to be limited. Central banks might be better advised to reduce risk through diversification of asset classes rather than through switching currencies, he suggested. Countries could well prefer to continue holding dollar assets “for a variety of different reasons.”


The euro has risen to an all-time high against the yen and to its highest level in several years against the dollar. This has been attributed to the improved economic outlook for the euro area and to rising interest rates in the European Union. But Goldman Sachs International vice chairman Robert Hormats, told Emerging Markets that the euro’s strength reflects what appear to be sizeable shifts of funds out of dollars and into euro.


Summers told a World Bank seminar that he hoped various countries or regions would develop deeper and more liquid asset markets to allow greater currency diversification of reserves. But this was unlikely to happen in the near term, he suggested. Meanwhile, “the potential to move into equities on a global basis represents an opportunity to diversify on a very significant dimension”.


East Asia’s efforts to develop deeper and more liquid national bond markets and regional bond markets are a welcome development, Summers suggested. “But I don’t think that this will significantly affect the pattern of global financial imbalances, he added.”.


Mexico's central bank governor Guillermo Ortiz, told the seminar that Brazil would continue diversifying its reserves out of dollars. Traditionally, the bulk of these reserves had been held in dollar form, because “80% of our trade s with the United States.” . “We have been diversifying our reserves,” Ortiz said. “You cannot speculate on a day to day basis [but] our aim is to gradually diversify.” Neverethless, the bulk [of our reserves] will probably remain in dollars,” he added.


Indian Reserve Band governor Y,V Redly defended the policy of many Asian central banks to hold large foreign exchange reserves. These “may be needed as a cushion if markets become unstable, he said. “Liquidity in developed economies might suddenly dry up and central banks needed to maintain a certain “comfort level.” to guard against this. “So far, the market has not been tested,” added Redly.

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