Dec. 6, 2004
Bloomberg
"Et tu, Indonesia?'' It was with this question that Oxford University economist Brad Setser began a recent report on the U.S. dollar's mounting problems. It is appropriate for its global implications.
The reference, of course, is a play on William Shakespeare's ``Julius Caesar,'' in which Caesar utters the words ``Et tu, Brute?'' (Even you, Brutus?) upon learning that his friend Brutus is among the assassins stabbing him to death.
No, Indonesia isn't stabbing the U.S. in the back, regardless of what some in Washington may think as it considers trimming its holdings of U.S. Treasuries. Aslim Tadjuddin, deputy governor for monetary policy at Indonesia's central bank dropped that bombshell in a recent Bloomberg interview.
Indonesia's was merely the latest central bank to suggest that it may sell some U.S. Treasuries if the dollar continues to decline. Just days earlier, Russia's central bank rocked currency markets by suggesting it may swap from dollar-denominated assets to euro assets.
China also raised eyebrows late last month after China Business News reported Beijing had cut its U.S. debt holdings. The news shook markets because China's $174 billion of Treasuries makes it the second-biggest holder after Japan. While a Chinese central bank official said the report was ``distorted,'' markets fear the worst.
Taiwan, the world's third-largest holder of foreign-exchange reserves, had to deny reports it planned to reduce U.S. debt holdings as the dollar slides. Such a move by the island, which has $57 billion of Treasuries, would surely boost U.S. debt yields.
Reluctant Banks
Central banks are loathe to confirm they're dumping Treasuries; the mere announcement will drive down bond prices, forcing them to eat even bigger losses than they have to date. Regardless of what central bankers here say, however, Asians are increasingly looking to front-run big losses on their U.S. Treasuries holdings.
The real question is when Japan will join the fray --it is by far the biggest holder of Treasuries among central banks, with about $740 billion. If Tokyo gets uneasy about the falling dollar boosting bond yields, officials could very well pull the plug on the U.S. That would probably lead to copycat sales by other nations, especially here in Asia.
U.S. Treasury officials couldn't have been happy with recent comments by Kaoru Yosano, a senior member of Japan's ruling Liberal Democratic Party. ``The Japanese government is going to ask for a strong dollar policy,'' he said. ``If it continues to fall, there would be enormous capital flight from the dollar.''
Reminder
Some currency traders interpreted that as a veiled threat that Tokyo may begin trimming its Treasury holdings. Perhaps markets misunderstood Yosano, yet many can't help but recall an episode seven years ago when such a scenario seemed all too possible.
``Actually,'' then-Japanese Prime Minister Ryutaro Hashimoto told an audience in New York in June 1997, ``several times in the past, we have been tempted to sell large lots of U.S. Treasuries.''
One such occasion, Hashimoto said, was during Japan's negotiations with the U.S. over auto sales. Or when ``the exchange rate has suffered extreme movements and the American people have done little but look at domestic issues.'' Hashimoto summed things up this way: ``We were very tempted on these occasions. However, in terms of fund management, we did not take the most advantageous road.''
Reality Check
Japan spent the next few weeks doing damage control, claiming Hashimoto had been misinterpreted. Yet the inference seemed clear. The prime minister had just come from a Group of Eight summit in Denver that featured considerable U.S. chest- thumping about its booming economy. Japan's leader was merely reminding Washington that while it had created a robust, highly productive economy, Asian central banks hold the deed.
Whether Japan would dump vast amounts of U.S. debt is anyone's guess. It would be a mistake to ignore the risk, as Federal Reserve Chairman Alan Greenspan suggested last month when he said foreign demand for U.S. assets might wane.
Greenspan's worry is that investors are suddenly realizing the U.S. current-account deficit -- approaching a record 6 percent of the economy -- is a problem. It may make dollar- selling the trade of choice in markets everywhere.
Japan's Next Move
Again, all eyes are on Japan. Its much-hyped economic recovery is losing steam and the yen's rise this year is a growing headwind. And investment banks like Morgan Stanley are lowering their forecasts for the dollar. Against the yen, the bank reduced its June estimate to 95 from 115 and cut its year- end 2005 projection to 92 from 117.
That would undermine not only Japanese growth rates, but also the handful of exporters driving the recovery. Japan's tolerance for a rising yen is being severely tested. That's especially true amid the perception the U.S. now favors a weaker dollar and the Bush administration seems likely to widen an already record budget deficit.
If Japan turns on the U.S. bond market, expect Asia's central banks to follow suit. That would slam the U.S. bond market considering the combined U.S. Treasury holdings of China, Hong Kong, Japan, Singapore, South Korea, Taiwan and Thailand come to $1.1 trillion.
Debt investors the world over have been wondering if Asia's central banks will pull the rug out from under the U.S. bond market. Such a step may indeed be close at hand.
To contact the writer of this column:
William Pesek Jr. in Bangkok through the Tokyo newsroom at wpesek@bloomberg.net, and.
To contact the editor responsible for this column:
Bill Ahearn at bahearn@bloomberg.net.
Last Updated: December 5, 2004 19:08 EST
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