Central Bank Blues

In a fairly ironic and cryptic post yesterday I alluded to the potential influence of the Russian central bank on the value of the euro. This situation is not to be taken lightly. The euro today hit another record passing the 1.32 to the dollar mark. At the same time business confidence index readings from Germany and Italy indicate that those who need to export are none too happy about the future.

A Russian move to raise euro reserve holdings from 30% to 40% of the total, mentioned as a possibility in an FT article yesterday, could have profound consequences:

Neil Mellor, currency strategist at Bank of New York, raised the prospect of a potential domino effect: ?Talk of central banks readjusting their reserves to encompass a greater euro weighting has been rife in the foreign exchange markets for quite some time, along with speculation that OPEC members may shift to euro-denominated oil sales.

?A dam can only take so much pressure. Russia?s stated intent to review its reserve weightings, in favour of the euro once again, could well lead to similar announcements by its counterparts across the world.?
Source: Financial Times

So the danger is that if Russia initiates others may follow. A fall in the dollar’s value of say 30% over 3 years would be one thing, but a rapid fall of this kind of magnitude precipitated by a shift in central bank holdings over a limited time horizon would be quite another. This is definitely one to watch.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

4 thoughts on “Central Bank Blues

  1. Does Russia have an interest in its major trade partners’ economies crashing?
    I think not. This threat is a tool of bargaining and won’t be used if both sides keep a minimum of calm. Calm pragmatist is a very accurate description of Vladimir Putin.

  2. Even more significant is China’s warning to the US that it must put its house in order (front page of the FT) and remarks reported in the Boston Herald from Morgan Stanley’s chief economist that the US is haeding for economic armageddon.

    Nobody wants the dollar to crash, because everyone has huge dollar reserves (the value of which they’d like to retain). However, nobody belives the dollar’s a good investment either. So everyone’s trying to divest of dollars on the quiet. And that makes the euro ever stronger.

    The dollar really could crash and within a few short months oil could be priced in euro. That’s no small thing.

  3. Indeed, one assumes the impact is if people think it might be the start of a similar move by China, the little Chinas, or Japan. Russia’s forex reserves just aren’t that large on their own.

    I don’t know the composition of European government debt, but thinking about it does rather raise the nice prospect that it’s Italian government debt that would become the world’s preferred reserve asset. Who’d have though it?!

  4. re Morgan Stanley economist: I can’t think of any time over the last eight years when Roach hasn’t been a major bear. He was bearish even as the dotcome bubble was inflating and everyone else was getting rich being bullish. Two and a half years is a long time to be wrong in financial markets.

    The euro will have to rise nearly to $1.50 to meet the former D-mark high against the greenback. We may get there, but even that may not be disastrous. Since 1986 (which begins to approximate the long term), the dollar-euro exchange rate (based on D-mark exchange rate pre-2002) has varied from $0.65 per euro to $1.45 per euro.

    I’m not saying a crisis is out of the question, but the trading relationship and the economies in question have weathered quite substantial changes in the exchange rate over time. There’s a high hurdle to get over in explaining why this time is different.

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