We maintain our view that the dollar will likely remain the dominant international currency for the foreseeable future. Available data do not unambiguously support the view that central banks in the world have been aggressively diversifying from the USD. While assets denominated in EUR have experienced a sharp improvement in liquidity and depth since the establishment of the EMU, Asia and other parts of the world continue to rely on the USD as the medium of exchange and unit of account. The ‘incumbent advantages’ that the dollar enjoys will be difficult to overcome. The most likely challenger to the USD will be the CNY or an Asian currency unit centred on the CNY. But the key precondition is that Asia manages to develop its financial markets.
Weekly Bank Research Center 04-21-08
Are Central Banks Aggressively Diversifying from USD Assets?
Stephen Roach, Head Economist, Morgan Stanley
There are different ways of thinking about this question. The most popular data that investors refer to are the IMF’s COFER quarterly data on the currency composition of the world’s reserve holdings. (Not all IMF member countries that report the aggregate reserve positions also report their currency compositions. Specifically, as of end-2007, the COFER data on currency composition cover only 64% of the world’s reserves.) According to these data, the USD’s share in total world foreign reserves has declined from 72.7% in 2001 to 63.9% as of end- December 2007, with developed economies having a higher (69.4%) concentration of USD holdings than developing countries (60.7%). During the same period, EUR’s share rose from 17.6% to 26.5%, with developing economies having a higher exposure to the EUR (29.0%) than developed countries (22.2%). Thus, the short answer to this question is ‘yes’, there has indeed been a decline in the USD’s share in the world’s official reserve holdings in the past few years.
Economy Still in the Doldrums
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Incoming data during the week have changed little about the picture of a US economy caught in the unfortunate position of having both high inflation and flagging growth. First, the retail sales figures for March confirmed that the weak consumption trend is continuing. Although there was not an actual decrease in private consumption, growth slowed markedly from 2.3% q/q AR in Q4 to 0.5% q/q AR in Q1. One of the main reasons for this slowdown is the sharp increase in energy and food prices, which have been pushing up inflation and pulling down real wages since the end of last year. Nor were there any signs of any real improvement in this week.s figures. Both consumer and producer prices continued to climb fast in March, and with energy and food prices still rising, inflation will not be returning to normal levels in the immediate future. There is probably therefore no prospect of any improvement in private consumption until the tax cuts come into effect in May.
Does Chinese Inflation Mean Higher U.S. Inflation?
E. Silvia, Ph.D. Chief Economist, Wachovia
Chinese CPI inflation has risen quite sharply lately, and the media is filled with stories of significant wage increases in China this year. In addition, the dollar has depreciated versus the Chinese renminbi lately. Because it seems like the United States imports “everything” from China, some investors fear that the overall U.S. CPI inflation rate will likewise head higher. In our view, these fears are misplaced. Imports of goods from China account for, at most, eight percent of U.S. consumption expenditures on durable and nondurable goods, and imports of services from China are small. Because imports of goods and services from China represent only a small proportion of total U.S. consumer expenditures, rising import prices from China (and more broadly the entire world) have a relatively small effect on overall U.S. CPI inflation.
Little Risk of Crashing Oil Demand
Steve Chan, Economist, TD Bank Financial Group
Global consumption trends have remained quite robust in spite of the current weakened state of the U.S. economy. However, the economic slump south of the border will eventually spill over into the global market. As such, we have downgraded our global growth forecast from 3.8% to 3.6% for 2008 and from 3.7% to 3.3% for 2009 in the latest edition of the TD Quarterly Economic Forecast. Given that oil consumption is closely tied to world economic growth, the global slowdown forecast is likely to soon show up in the demand equation. There has been some evidence emerge that consumers in the U.S. are beginning to adjust their behaviour in order to minimize the pinch being felt on their wallets. Over the past year, there has been a more than 2 percentage point swing in the market share from light trucks towards smaller, more fuel efficient vehicles. Moreover, during the first quarter of the year, total oil product demand in the U.S. (i.e., crude oil and refined products) declined by 3%. That said, we see a limit to how far demand will slacken, since with few available alternatives, oil consumption is relatively price inelastic.
Emerging Markets to the Rescue of the World Economy?
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
Global economic growth last year was 4.7%, maintaining the extremely strong pace of the last four years. The main impetus for that growth came from the emerging markets. Growth in the US was just 2.2% and 2% in Japan, the first and second largest economies in the world, respectively. With consensus forecasts for 2008 suggesting that these two economies will expand at an even slower pace, 1.6% in the US and 1.4% for Japan, the question is what will happen to global growth? One worry has been that, with the US skirting recession, will the world economy experience recessionary conditions as well? Our view is that the world economy will be able to absorb the slowdown of the US, and a number of other developed economies, including the UK. There will be a slowdown in the global economy, but growth should still be a respectable 4.3% because of the strength of emerging market growth. What has changed to make emerging market growth so stable and less dependent on the US?
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