Foreign Exchange Reserves Are Concentrated In Weak Currencies

By: Daniel Aaronson & Lee Markowitz | Fri, Feb 5, 2010
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Global foreign exchange reserves used to be largely held as US Dollars. However, the introduction of the Euro and growing fears of the United States' budget and trade deficits led central banks to diversify their foreign exchange reserves away from Dollars. Figures 1 and 2 illustrate that as a percentage of reserves, Euro holdings increased from 19% to 25% even before the present financial crisis, while dollars fell from 72% to 65% of total holdings by 2006. Given the growing US deficits, central banks had good reason to diversify their holdings, but because of the current sovereign problems in the Euro-zone, this may have been a wasted effort. Now, China and other central banks are confronted with finding alternatives to both the Dollar and the Euro. While gold has recently been falling as a side effect of a declining Euro, the Euro-zone problems aptly demonstrate why everyone (investors, central banks, and the general population) must diversify out of developed world currencies and into gold.

Figure 1. Total Foreign Exchange Holdings (in millions of U.S. Dollars)

Larger Image

Source: IMF

Figure 2. Composition of Allocated Reserves

Source: IMF, Continental Capital Advisors, LLC

The concentration of reserves in questionable currencies suggests that central banks will be faced with continuing challenges, but no nation's course of action will be more influential than that of China's. China is currently faced with two dilemmas regarding its foreign exchange reserves. First, China needs to invest the new Dollars and Euros it receives from its trade surplus with America and the Euro-zone, and secondly, China will have to make crucial decisions about the composition of its existing $2.4 trillion of reserves. Thus far, China has begun this process by converting a portion of its new trade Dollars into Euros and commodities. However, given the problems in the Euro-zone, that strategy will likely need to be revised. For example, Yu Yongding, a former adviser to the Chinese Central Bank, said that China should not buy a "large chunk" of Greek government debt because the securities are more risky than U.S. Treasuries. So far, China has done little to diversify its existing reserves and because the universe of freely trading currencies outside of Dollars, Euros, Yen and Pounds is relatively small, China (and other central banks) must allow its currency to appreciate while continuing to diversify into resources and gold. However, with markets quickly understanding the fiscal problems of the US and Europe, the window of opportunity to execute this strategy is rapidly closing.

 


 

Author: Daniel Aaronson

Daniel Aaronson
Continental Capital Advisors, LLC

Continental Capital Advisors, LLC was formed to offset the destruction of wealth caused by the global devaluation of currencies by central banks. The name Continental Capital symbolizes the 1775 US Currency, "the Continental", which was backed by nothing and quickly became devalued.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Any action taken as a result of reading this is solely the responsibility of the reader.

Copyright 2009-2012 © Continental Capital Advisors, LLC

Author: Lee Markowitz

Lee Markowitz CFA
Continental Capital Advisors, LLC

Continental Capital Advisors, LLC was formed to offset the destruction of wealth caused by the global devaluation of currencies by central banks. The name Continental Capital symbolizes the 1775 US Currency, "the Continental", which was backed by nothing and quickly became devalued.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Any action taken as a result of reading this is solely the responsibility of the reader.

Copyright 2009-2012 © Continental Capital Advisors, LLC

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