Dollars to doughnuts

Cernig started up a discussion about Iran's move to the Euro and whether it will have an impact on the valuation of the US dollar. As a matter of supply and demand of US dollars on international money markets, the short answer is that it must. But Iran alone will not cause a large devaluation, but Iran is not pursuing its divestiture of US dollar assets by itself. Foreign Policy's top ten stories point out, at number 8, Russia and OPEC have already begun dumping dollars:

The latest Bank for International Settlements quarterly report, which tracks the investment trends of oil-producing countries, indicates that Russia and OPEC countries are moving their holdings out of dollars and into euros and yen. OPEC cut its holdings in the dollar by more than $5 billion during the first and second quarter of 2006. And Russia now keeps most of its new deposits in euros instead of dollars.China's willingness to support the currency has had a wide-ranging effect on U.S. assets, and a liquidation if its dollar holdings in favor of other denominations would undermine stocks, U.S. Treasuries and corporate bonds, as well as the U.S. currency itself.

That decrease is swift and significant—and helps to explain why the dollar recently fell to a 20-month low against the euro and a 14-year low against the British pound. Holding dollars while other currencies gain strength means less profit for oil producers. But if they rapidly divest themselves of dollars, it may weaken the currency and push up inflation in the United States.

Of course, this places the largest US dollar asset holders, China and Japan, in a very serious situation. They are caught between holding huge sums of dollars -- hundreds of billions -- watching that value drop on world markets but know that if they start to divest, they would loose billions more as the glut of dollars would sink the value of the US dollar even further. Which might make one think that China and Japan would try to prop up the dollar but ... China has already announced that they would "diversify" their holdings away from US dollars.

China's latest comments suggesting that it will diversify its $1 trillion in currency reserves has unsettled Wall Street at a time when confidence is running high....

Still, China's willingness to support the currency has had a wide-ranging effect on U.S. assets, and a liquidation if its dollar holdings in favor of other denominations would undermine stocks, U.S. Treasuries and corporate bonds, as well as the U.S. currency itself.

The concerns over dollar assets mounted this week after Zhou Xiaochuan, the Chinese central bank governor, said that China planned to diversify its assets across different currencies and investment instruments, including emerging markets. The dollar, which analysts reckon make up around 70 percent of China's reserves, fell to 2-1/2 month lows against the euro as his comment hit trading.

USD/Euro v. time

This announcement by Chinese came just prior to the 20 month low mention above. Though the dollar has recovered a smidge in recent days, the trend is unmistakable. And the Iranian announcement will not help this picture at all. I am considerably less than swayed by arguments that the dollar is not in trouble, as Fester seems to be. There are many forces now acting to push the dollar down and this is a growing and worrisome trend.