Paul,
<China will not be compelled to be as active in the US treasury auctions. Their reduced participation would cause interest rates in US to rise.>
I think CB's look at their reserve holdings on a trade-weighted basis. We investors tend to look more at the trading opportunities. CB's look at trade by currency and to a certain extent allocate foreign reserves in the same proportion. So, as much as the dollar bears might like to see a 0% allocation in the dollar, which as you rightly say, would spike US interest rates, this is quite unlikely. The reason is that China's trade with the US and this warrants a significant reserve of USD to manage that trade. Now, if a CB elects to have no foreign reserves, that is a different story, but if a CB is holding reserves and they do not have them allocated in close proportion to their trading volumes, they could get into trouble with exchange rates. Imagine holding Swiss Francs and be unable to manage volatility in the dollar, for example. That would be imprudent. How much use is those Swiss Francs if you would like to sell dollars to stem a rise in your own currency to help your exporters continue to sell to the US? Selling Francs would have a muted impact, selling dollars has a direct impact.
I see Asian CBs have lowered allocations from the 80% range to the 60% range. Going lower than that is not inconceivable, but one could argue its imprudence.
D |
