Dollar bulls are an endangered species. Once seen stampeding across the investment landscape, they’ve been all but wiped out by bears fed on a diet of headlines about global imbalances. So if everyone is so convinced that the greenback is doomed to fall, how long can it be before the message seeps through to the corridors of central banks?
Some countries have already got the message – Sweden, Qatar and Russia were last month reported to be planning diversification – but even so, more than two-thirds of the world’s currency reserves are still denominated in dollars. About a quarter is in euros, a proportion that looks certain to increase, dragging the currency higher.
“The scope is quite literally enormous. If you look at Chinese and Japanese reserves, there are huge quantities there, and in terms of diversification so far they’ve only scratched the surface,” says Andrew Clare, professor of finance at London’s Cass Business School and an adviser to investment firm Legal & General. “There’s definitely upside for the euro,” he concludes.
China, with the world’s biggest currency reserves – more than $850 billion – could hold the key. People’s Bank governor Zhou Xiaochuan told Emerging Markets exclusively that the country is ready to shift its holdings if the international environment changes.
For the moment he’s satisfied: “I think we manage our foreign exchange reserves with very good performance that’s quite efficient,” he says. But “It doesn’t mean we don’t need to change, because the world is dynamic, so if the situation changes, the currency relationship changes and investment opportunity changes. Certainly we are going to catch that.”
Faster
The trend is clear, and the euro bandwagon is already gathering speed, aided by suggestions that the Federal Reserve may nearly be done raising rates just as the European Central Bank is getting started. Some states have already made the switch; others are in the process: “I think many countries would rather have a balanced portfolio; our reserves are well diversified,” says Malaysian second foreign minister Nor Mohamed Yakcop, sitting beside the deputy governor of the country’s central bank, in an interview with Emerging Markets.
With the world’s developing countries holding a growing share (currently 70%) of total reserves, the risk for those that are slow to switch out of dollars is that hard- earned export cash could waste away in central bank vaults. A benefit for those that move is that breaking the dollar link could help wean their economy away from dependence on the US, allowing a better spread of risk.
Structural and cyclical indications are all pointing in the same direction for the euro as Germany, the continent’s traditional powerhouse, finally embarks on a genuine recovery. “Growth is definitely stronger as a result of exports; that’s beginning to trigger bigger investment,” says Trevor Williams, chief economist at Lloyds TSB. The conclusion: “The euro’s going up.”