Rally di Natale a Wall Street?

Observers of international finance have long puzzled over the durability of the Dollar’s predominance in official foreign exchange reserves.

The International Monetary Fund (IMF) reports that 61% of allocated aggregate reserves are held in Dollars.

This is despite the Dollar’s 18% decline against major currencies and its 62% and 52% depreciations against the Deutsche Mark/Euro and the Yen, respectively.

Moreover, the U.S. economy’s share of Global GDP has shrunk by 6% since 1978.

If one takes the size of the U.S. economy to explain the Dollar’s share, then one might infer that this share would decline only slowly unless and until another economy surpasses the U.S. economy in size.

A long-standing puzzle in international finance is the durability of the Dollar’s share of foreign exchange reserves – which remains above 60%, while the weight of the U.S. economy in Global output has fallen to less than a quarter.

In the article, the Authors[§] argue that the Dollar’s role may reflect instead the share of Global output produced in Countries with relatively stable Dollar exchange rates – the “Dollar-zone”.

This special feature proposes an alternative interpretation based on the size not of the U.S. economy but rather of the “Dollar-zone”.

If a currency varies less against the Dollar than against other major currencies, then a reserve portfolio with a substantial Dollar share poses less risk when returns are measured in domestic currency.

Time series and cross-sectional evidence supports the link between currency movements and the currency composition of reserves.

In Countries whose currencies are more stable against the Dollar than against the Euro, “a reserve composition that favours the Dollar produces more stable returns in terms of the domestic currency”.

This alternative interpretation implies that currency shares could shift rapidly, as happened between the World Wars.

Its choice depends on the intended uses of the reserves.

If reserves are held mainly to intervene in the currency market, then a plausible numeraire would be the currency against which the domestic currency trades most heavily, especially in the spot market where most Central Banks operate.

If reserves are held mainly to insure purchases of foreign goods and services, then an import basket would be plausible.

Or, if reserves are held mainly as a hedge against (or to pay) debt service, the currency composition of outstanding debt would be a plausible choice.

? Does a currency’s Dollar weight influence the share of the U.S. Dollar in the corresponding Country’s official reserves ?

Yes, the limited cross-sectional evidence strongly suggests – [see to the page 28 / 36 (or 6 / 14) the Graph 3 – in the link § at the end].

Broadly, Central Banks in the Americas heavily weight the Dollar, which remains the most important influence on their currencies despite the rising importance of the Euro.

Most European Central Banks don’t hold such a high share of Dollars, and Russia, Turkey, the United Kingdom, Australia and New Zealand are in between.

Two thirds of the cross-sectional variation in the Dollar share in foreign exchange reserves can be accounted for by the currencies’ average “Dollar-zone” weight in 2010-2013.

The slope of the least squares line (in red in Graph 3) is not 1 (dashed blue line), as would be the case if reserve managers on average chose the Dollar weight to minimise the variance of their portfolios in domestic currency.

Instead, the estimate of the slope of one half points to some departure from the minimum variance portfolio, perhaps in some cases to raise expected funds.

? Where might the largest reserve holder, China, place on Graph 3 ?

If its reserve composition was at the average for Emerging market economies reported to the IMF, then China would be the largest outlier: with only 60% of reserves held in the Dollar on the vertical axis but a calculated “Dollar-zone” weight of 93% on the horizontal axis.

If market estimates of a lower Dollar share are given credence, China would be a larger outlier.

But if the medium-term management of the Renminbi is interpreted as an upward crawl against China’s trade-weighted basket, then the “Dollar-zone” share would be about half, lower than the estimate based on weekly changes.

Offshore bank deposits include some official holdings, but would usually be dominated by holdings of Banks, firms and some Households.

The relationship is remarkably similar to that between the “Dollar-zone” weight and official reserve composition.

The Dollar share of deposits is somewhat higher (larger estimated intercept) and responds more strongly to the “Dollar-zone” share (steeper estimated slope), and overall is more tightly related to the “Dollar-zone” weight, with 81% of its variance accounted for.

In any case, any notion that official reserves hedge or provide for the servicing of foreign currency debt only reinforces the rationale for matching the reserve composition to the “Dollar-zone” share.

Portfolio considerations seem more important than trading in the spot market.

A currency’s co-movement with the Dollar bears a robust relationship to the Dollar share of assets and liabilities. Currency geography is portfolio destiny.

The logic underlying both private and official behaviour is straightforward.

The Dollar looks less risky as an investment or a borrowing currency the more closely the domestic currency moves with the Dollar.

Looking forward, the findings also have implications for the possible evolution of the currency composition of official reserves.

The results suggest that changes in the co-movement of currencies could result in more rapid than commonly thought shifts in the composition of reserves, potentially eroding the weight of the Dollar.

By the same token, they indicate that Country size alone may be less relevant.

If correct, these findings have implications for the future of the Renminbi.

The continued relatively rapid growth of the Chinese economy, even if accompanied by developing money and bond markets, opening of the capital account and floating of the Renminbi, “might not be sufficient for the currency to eclipse the Dollar in official reserve holdings”.

By contrast, if the Renminbi at some point showed substantial independent movement against the major currencies and if its neighbours’ and trading partners’ currencies shared that movement, then it might be said that “the Renminbi-bloc [i.e., zone] is here”.

In that case, official reserve managers might hold a substantial share of Renminbi, perhaps not too far from their currencies’ “Renminbi-zone” weights.

°l°

The result doesn’t depend on pegs.

All in all, the relationship doesn’t depend on economies where the currency is heavily managed.

°l°

l- – – – –

l-§-l R. McCauley, T. Chan (Bank for International Settlements), “Currency movements drive reserve composition”, BIS Quarterly Review, December 2014: Special Features – December 7, 2014

https://www.bis.org/publ/qtrpdf/r_qt1412e.pdf

– – – – -l

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E’ bello vedere la qualità dei blog che si autoalimenta http://icebergfinanza.finanza.com/2014/12/19/merry-christmas-casino/ Si lo so Danilo che non è stampa estera. Ciao.

kry@finanza,

E che c’entra la stampa estera? Diciamo che io e Andrea spesso la pensiamo allo stesso modo anche perchè…ormai è impossibile negare l’evidenza.
Segnala anche questo post (più altri) da lui come fai qui! Grazie!

Dream di solito non c’è due senza tre per cui oggi altra candela. Dalla settimana prossima che si fà accendiamo i ceri per non far crollare tutto.

Danilo DT,
E’ una battuta in quanto una volta mi dicesti che leggi solo stampa estera per non farti influenzare. Per quanto riguarda la segnalazione dei post non la faccio a senso unico e noto che da un pò di tempo ci sono frequentatori comuni da entrambe le parti e di questo non posso che rallegrarmi. Riformulo il precedente commento: sono contento che in un paese d’individualisti ci sia della condivisione tra blogg nel fornire buona informazione. Complimenti e grazie. Con stima Kry. Ciao.

kry@finanza,

scusa Kry, i thd in questione non ti sembrano leggermente prolissi ?

Concordo invece con te sul fatto che gli Italiani siano più individualisti ( e creativi!), piuttosto che comunitari (team).