Record Levels of Currency Reserves Will Hit Hard

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When the US federal government was shutdown, China jumped in on the financial bandwagon and suggested that we build ‘a de-Americanized world’, which boils down to getting rid of the dollar as the international reserve currency. As the law-makers and the political parties were dragging their feet, the Chinese had their running shoes on to sneakily knock a dead man down again as he was trying to get up. Well, all is fair in love and war and we should expect nothing less.

The official Chinese state-run news agency (in mocking tone) stated: “As U.S. politicians of both political parties are still shuffling back and forth between the White House and the Capitol Hill without striking a viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanized world”. But, has that dream come true? Has the shutdown affected the reserve currency of the world and is the dollar on its way out?

South Korea

It may not be on its way out just yet, but if the South Koreans are anything to go by, they are prepared to do quite a lot of damage if they have to in order to prevent their own currency the won.

Data released today by the Bank of Korea show that the country has been hording foreign exchange reserves (which currently stand at $343.23 billion at the end of October 2013).
This means that there has been an increase of $6.3 billion compared to September 2013.
You would have to go back at least two years to find that sort of figure.
This is primarily due to the fact that the won has risen by more than 9% over the past 4 months.
By buying up large quantities of dollars they have been able to preserve an even greater rise in their currency.
The South-Korean economy is dependent on exports for its economic-growth prospects and any increase in its currency means they are going to slow down.
South Korea’s growth (of Asia’s 4th largest economy) was lowered for 2014 from 4% to 3.8%.
Growth this year stands at 2.8%.
If and when stimulus stops, the South Koreans will have a huge stockpile of dollars to play with and to counterbalance an outflow of cash back to the US.

Reserves and the Fed

More than 60% of reserves at central banks around the world are in dollars today and that means that if those central banks need to (and they will!) protect their own currencies, then they will not hesitate for one moment about flooding the financial market when the time comes so that they don’t lose out on liquidity in tough times. But, flooding the market with dollars will be bad news for the US. International banks have roughly $850 billion in US dollars at the moment in their vaults and will be able to ride out a future storm.

Despite the pig debt oinking over the EU and the troika today meeting with the Greek Finance Minister over the bailout program (there is a fear over the return of the creditor into Greece due to differences regarding the Greek funding gap) there is one big difference today in comparison with the financial crisis of the subprimes.

That difference is that the central banks were not prepared for it.
Today, they have reserves of cash, largely due to buying up huge quantities of Quantitative Easing.
The EU bought $74 billion in Q1 and $52 billion in Q2.
In fact, the real beneficiary of Quantitative Easing is the financial system and the US Federal Reserve has been filling the coffers of central banks around the world, rather than giving it to its own economy.
That’s another reason to criticize easy, loose monetary policies (at least from one side of the Atlantic).

Large reserves of the dollar around the world are just waiting there to be used when the economies need it. The central banks are stockpiling dollars in a bid to make their currencies go down against the dollar and at the same time make the dollar scarce so that it is in demand and rises. If it comes to the crunch, then they will have liquidity still even if their economies go downhill and it will be all thanks to Quantitative Easing and the Federal Reserve. The US stock market is on a high, the chapagne corks are popping and the fizz is being drunk down. But, the paradise is fool’s one and nothing more. It’s an unreal one that will run into problems sooner or later. The fact that the USA is the biggets debotor in the history of the world right now means that it will have little recourse to counter any economic trouble lurking around the corner (except continue printing money?).

There have been slowdowns in the US economy on cycles of roughly six years. Each time they have got progressively bigger and stronger. The next one will hit then in about 2014-2015, just in time for Quantitative Easing to be a real problem.

But, it will have done one thing: allowed foreign central banks to artificially maintain their currencies lower than they should be and to therefore appear to be more competitive. It will also enable those same economies to have greater financial independence than the US when the trouble knocks on the door.