It makes little sense to park hard-earned foreign exchange reserves in rapidly
depreciating US dollars. The argument used to be that investing in US treasurys was as safe as houses, which is why countries thought they were the best place to park their surpluses. We know now, unfortunately, that neither houses nor US treasurys are as good investments as they were supposed to be. That has led to dire warnings that countries would be diversifying their holdings away from dollar-based assets. China has been commended for sagely using its dollars to stockpile commodities it needs, rather than putting them in US fixed-income securities.
The US Federal Reserve, however, publishes data on what it calls “marketable securities held in custody for foreign official and international accounts”, or US assets accumulated by foreign central banks. What is remarkable is that despite the huge fiscal deficits being run up by the US government, in spite of the very low interest rates on US treasurys and despite the depreciation of the dollar, the rate of growth of these “custody holdings” has been 17.5% year-on-year. As the chart shows, that’s not too different from the 18.4% growth during the previous one-year period, from 5 December 2007 to 3 December 2008. And it’s much higher than the rate of growth of these holdings in 2005 and 2006, when the boom was in full swing. So not only have countries been adding to their dollar hoards, they have been doing so at more or less the same pace that they used to.
Graphics: Ahmed Raza Khan / Mint
Of course, there are signs that there is some diversification taking place, such as India’s purchase of 200 tonnes of gold. International Monetary Fund data shows that there is a steady fall in the proportion of dollars in official reserves over the past decade. In the “foreign custody” data, too, there are signs that the pace of increase is slackening. For instance, custody holdings went up far more in the six months between 3 December 2008 and 3 June 2009 than in the following six-month period. While they were up 9.5% in the first six months, they rose by 7.3% in the next. The numbers may understate the trend towards diversification, because we know that fund flows to emerging markets have soared in the last six months and many central banks have been buying dollars in order to keep their currencies from appreciating.
Nevertheless, the data does seem to show that diversification away from the dollar is a very slow process and US assets remain a very strong preference for foreign central banks, despite all their negative features. Ironically, while central banks are piling on to US assets, US investors have been pouring funds into emerging markets.
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