Appeal of euro strengthens against U.S. dollar
Appeal of euro strengthens against U.S. dollar
By Jeremy W. Peters
Copyright by The International Herald Tribune
Published: January 1, 2007
Countries that hold large amounts of the dollar are showing a new willingness to dump the dollar in favor of the rising euro.
Last week, the United Arab Emirates announced that it would shift more of its currency reserves away from the dollar, joining countries like Russia, Switzerland and Venezuela.
Those moves come amid ambiguous recent signals from China about possibly pulling back from the dollar, and word last week from Iran, one of the largest oil producers, that it would prefer euro payments for oil, which typically is priced in dollars.
But currency experts said that, for a number of reasons, these turns away from the dollar were not likely to inflict long-term damage on the currency's value.
First, the motives of central banks that are adding other currencies to their reserves do not appear to be driven by the belief that the euro eventually will supplant the dollar as the world's currency. Rather, these central banks are doing what investors typically do to minimize risk: diversifying portfolios.
Additionally, the amount of U.S. currency moved so far has been relatively small in a global market that trades trillions of dollars a day — only about $2 billion in the case of the United Arab Emirates, for example.
"There is some indication that central banks are moving to diversify reserves, but it's at a very slow pace," said David Powell, a currency analyst with IDEAglobal, a market research firm. "Is it the start of a massive shift out of the dollar? I would say no."
Further, the lasting impact on the value of the dollar when foreign central banks invest in other currencies is far from certain, analysts said.
"Most people think it does not influence exchange rates for any long period of time," said Edwin Truman, senior fellow at the Petersen Institute for International Economics who served for more than two decades as the director of international finance for the Federal Reserve. "It has some day-to- day effects, but not any big effects."
News of the United Arab Emirates decision helped push down the dollar against the euro, the British pound and the Japanese yen last week. Last year, the euro appreciated more than 11 percent against the dollar. The British pound rose nearly 14 percent against the dollar in 2006.
But that does not mean that the slide of the dollar will get any steeper in 2007, experts said. In February 2005, for instance, speculation that the South Koreans were planning to diversify their currency reserves set off a decline in the dollar. For most of March, the euro traded above $1.30. By summer, however, the euro had fallen back to about $1.20, and it remained near or below that level for most of the year.
One reason the dollar is not likely to start flowing with great speed out of central banks is that foreign countries risk devaluing their investments if they do so. Even the slightest suggestion that a country is thinking about swapping dollars for euros sends the value of the dollar falling, and in turn hurts all foreign investors in U.S. securities.
The case of China, which, after Japan, holds more U.S. Treasury securities than any other foreign nation, offers an example of why countries would be reluctant to dump their dollar reserves. In October, the most recent month for which securities data are available from the U.S. Treasury Department, mainland China held $345 billion in securities from the Treasury. That was up from $301 billion a year earlier. Its currency holdings total $1 trillion: economists estimate that about $700 billion of that is in dollars.
In many ways, it is in China's best interest not to let the value of the dollar value slip.
Heavy sales of the dollar could make it hard for the People's Bank of China to prevent the yuan from appreciating against the dollar, and that would make Chinese goods less competitive in the United States. And if the dollar dropped, the value of Chinese holdings would decrease, limiting the lending ability of Chinese banks.
Nonetheless, the rising euro is something the United States and foreign investors cannot afford to ignore.
"You have to start to thinking that the euro can be of some risk to the dollar," said Shaun Osbourne, chief currency strategist at TD Securities in Toronto. "Over the course of the next five or 10 years, I don't think there's any danger that the dollar's preeminence is threatened. But in the long run, there is certainly the risk that does happen."
One issue driving investors away from the dollar is the possibility that interest rates in the United States and Europe may move further apart next year. Financial markets are expecting at least one interest rate cut by the Federal Reserve next year. That contrasts with predictions of further interest rate increases by the European Central Bank. Because returns typically rise with interest rates, the euro seems like a more attractive investment.
"A lot of foreign investors think the Fed is going to cut rates in 2007, and that's a rather dollar-bearish thing," said Julia Coronodo, senior economist with Barclay's Capital.
Some economists predict the dollar will fall even further in 2007. The euro finished the year at $1.31, and some economists said they saw it climbing near $1.40 — territory it had not reached in its seven-year history.
"We believe that the dollar's decline versus the euro has further to run, with $1.38 a possible destination for the pair over the next six months," said Tom Levinson, a foreign exchange strategist with ING Wholesale Banking in London.
Still, many economists were unwilling to predict that the almighty dollar faced an inevitable demise.
"The dollar is still the world's No. 1 currency, and it's going to stay that way," said Nigel Gault, chief United States economist for Global Insight, a market intelligence firm. "The euro is gradually going to become more important, but I don't see it becoming more important than the dollar."
Keith Bradsher contributed reporting from Hong Kong.
By Jeremy W. Peters
Copyright by The International Herald Tribune
Published: January 1, 2007
Countries that hold large amounts of the dollar are showing a new willingness to dump the dollar in favor of the rising euro.
Last week, the United Arab Emirates announced that it would shift more of its currency reserves away from the dollar, joining countries like Russia, Switzerland and Venezuela.
Those moves come amid ambiguous recent signals from China about possibly pulling back from the dollar, and word last week from Iran, one of the largest oil producers, that it would prefer euro payments for oil, which typically is priced in dollars.
But currency experts said that, for a number of reasons, these turns away from the dollar were not likely to inflict long-term damage on the currency's value.
First, the motives of central banks that are adding other currencies to their reserves do not appear to be driven by the belief that the euro eventually will supplant the dollar as the world's currency. Rather, these central banks are doing what investors typically do to minimize risk: diversifying portfolios.
Additionally, the amount of U.S. currency moved so far has been relatively small in a global market that trades trillions of dollars a day — only about $2 billion in the case of the United Arab Emirates, for example.
"There is some indication that central banks are moving to diversify reserves, but it's at a very slow pace," said David Powell, a currency analyst with IDEAglobal, a market research firm. "Is it the start of a massive shift out of the dollar? I would say no."
Further, the lasting impact on the value of the dollar when foreign central banks invest in other currencies is far from certain, analysts said.
"Most people think it does not influence exchange rates for any long period of time," said Edwin Truman, senior fellow at the Petersen Institute for International Economics who served for more than two decades as the director of international finance for the Federal Reserve. "It has some day-to- day effects, but not any big effects."
News of the United Arab Emirates decision helped push down the dollar against the euro, the British pound and the Japanese yen last week. Last year, the euro appreciated more than 11 percent against the dollar. The British pound rose nearly 14 percent against the dollar in 2006.
But that does not mean that the slide of the dollar will get any steeper in 2007, experts said. In February 2005, for instance, speculation that the South Koreans were planning to diversify their currency reserves set off a decline in the dollar. For most of March, the euro traded above $1.30. By summer, however, the euro had fallen back to about $1.20, and it remained near or below that level for most of the year.
One reason the dollar is not likely to start flowing with great speed out of central banks is that foreign countries risk devaluing their investments if they do so. Even the slightest suggestion that a country is thinking about swapping dollars for euros sends the value of the dollar falling, and in turn hurts all foreign investors in U.S. securities.
The case of China, which, after Japan, holds more U.S. Treasury securities than any other foreign nation, offers an example of why countries would be reluctant to dump their dollar reserves. In October, the most recent month for which securities data are available from the U.S. Treasury Department, mainland China held $345 billion in securities from the Treasury. That was up from $301 billion a year earlier. Its currency holdings total $1 trillion: economists estimate that about $700 billion of that is in dollars.
In many ways, it is in China's best interest not to let the value of the dollar value slip.
Heavy sales of the dollar could make it hard for the People's Bank of China to prevent the yuan from appreciating against the dollar, and that would make Chinese goods less competitive in the United States. And if the dollar dropped, the value of Chinese holdings would decrease, limiting the lending ability of Chinese banks.
Nonetheless, the rising euro is something the United States and foreign investors cannot afford to ignore.
"You have to start to thinking that the euro can be of some risk to the dollar," said Shaun Osbourne, chief currency strategist at TD Securities in Toronto. "Over the course of the next five or 10 years, I don't think there's any danger that the dollar's preeminence is threatened. But in the long run, there is certainly the risk that does happen."
One issue driving investors away from the dollar is the possibility that interest rates in the United States and Europe may move further apart next year. Financial markets are expecting at least one interest rate cut by the Federal Reserve next year. That contrasts with predictions of further interest rate increases by the European Central Bank. Because returns typically rise with interest rates, the euro seems like a more attractive investment.
"A lot of foreign investors think the Fed is going to cut rates in 2007, and that's a rather dollar-bearish thing," said Julia Coronodo, senior economist with Barclay's Capital.
Some economists predict the dollar will fall even further in 2007. The euro finished the year at $1.31, and some economists said they saw it climbing near $1.40 — territory it had not reached in its seven-year history.
"We believe that the dollar's decline versus the euro has further to run, with $1.38 a possible destination for the pair over the next six months," said Tom Levinson, a foreign exchange strategist with ING Wholesale Banking in London.
Still, many economists were unwilling to predict that the almighty dollar faced an inevitable demise.
"The dollar is still the world's No. 1 currency, and it's going to stay that way," said Nigel Gault, chief United States economist for Global Insight, a market intelligence firm. "The euro is gradually going to become more important, but I don't see it becoming more important than the dollar."
Keith Bradsher contributed reporting from Hong Kong.
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