By William Pesek Jr. Bloomberg http://www.bloomberg.com/apps/news?pid=71000001&refer=columnist_pesek&sid=aEBBmwvtNuxA
Jan. 28 (Bloomberg) -- Malaysia isn't a place traders look for clues about the U.S. dollar, yet Asia's No. 10 economy may be offering some ominous ones.
They can be found in a recent report on international reserve holdings at Bank Negara Malaysia, the nation's central bank. It states that Malaysia made a $2.1 billion "revaluation gain" in 2004, "arising mainly from the depreciation of the U.S. dollar against the major currencies."
Central banks are always reticent to detail their holdings, but one can't help but wonder if Malaysia is buying an increasing amount of euros -- or even yen -- these days. Its central bank sure didn't make that kind of cash holding the dollar, the currency to which its own, the ringgit, is pegged.
The plot thickens when you consider how such a shift away from the dollar would jibe not only with comments from top Malaysian officials, but trends throughout Asia.
Here in Malaysia, for example, Prime Minister Abdullah Ahmad Badawi recently said he is seeking ways to reduce the economy's reliance on the dollar for trade. Indonesia has mentioned it is considering trimming its holdings of U.S. Treasuries. The same goes for Thailand, according to the Financial Times.
China also has been in the news as traders speculate that Asia's No. 2 economy may pull the plug on dollar-denominated debt. Such a move by the second-biggest holder of U.S. Treasuries after Japan could send shockwaves through global markets.
Fan Gang's Comments
Hence all the fuss over comments by Chinese economist Fan Gang. Fan isn't a government official; he's director of the state-owned National Economic Research Institute in Beijing. The connection seemed close enough for traders who found great relevance in Fan's comment that China has lost faith in the dollar, to which its currency is pegged.
"The U.S. dollar is no longer, in our opinion is no longer, (seen) as a stable currency and is devaluating all the time, and that's putting troubles all the time," Fan said, speaking in English, at the World Economic Forum in Davos, Switzerland. "So the real issue is how to change the regime from a U.S. dollar pegging to a more manageable reference, say euros, yen, dollars -- those kind of more diversified systems."
Paul Donovan, London-based senior global economist at UBS AG, seemed to speak for many traders and investors when he said: "This in fact is a scenario we consider to be highly likely." Certainly more likely than, say, China letting the yuan trade freely.
Turning to the Euro
Again, Fan isn't a Chinese policy maker, and it's unclear how close he is to the economic decision-making process. Still, his views have a certain logic to them. Irony, too. The U.S. has been using its might to bully China into revaluing the yuan. Yet it seems it is U.S. weakness -- a fragile dollar -- that may be the catalyst.
It means now is as good a time as any for this region to avoid losses ahead of any surge in U.S. debt yields. After all, in real estate, it is all about location, location, location. With markets, it's timing, timing, timing, and waiting means Asian central banks may lose even more.
Confidence in the dollar wasn't enhanced this week by President George W. Bush's record budget deficit forecast of $427 billion for this fiscal year. It belied assurances that the White House will bring one of the world's most worrisome economic imbalances under control.
All this has investors turning to the euro. Once Asian central banks do, the dollar's woes will worsen. By buying vast amounts of Treasuries, Asian central banks are delaying the rise in U.S. yields that would typically accompany a falling currency. If Asians pull the plug, U.S. rates could skyrocket.
Reckoning Approaching?
Central banks here don't buy U.S. debt out of altruism. Hoarding dollars is necessary to hold down currencies to boost Asian growth. Yet dumping dollars would result in stronger Asian currencies and, by extension, Asian gross domestic product.
Smaller economies like Indonesia, Malaysia or Thailand may be able to trim dollar holdings without undermining their own economies. The same can't be said of Japan and China; combined, they own $906 billion of the roughly $1.1 trillion of U.S. Treasuries held overseas.
Still, the day of financial reckoning that investors fear may be getting closer.
It has long been said that Japan's bond market is a bubble waiting to burst. Even with a national debt approaching 150 percent of GDP, 10-year Japanese debt yields just 1.32 percent. Asians have to wonder if U.S. rates are irrationally low, too. Do yields at 4.19 percent for U.S. 10-year debt really compensate investors for the risks they face?
The U.S. finds itself in a be-careful-what-you-wish-for situation here. If China tomorrow announced it was letting the yuan float, as the U.S. wants, its central bank wouldn't need anything near the $191 billion of U.S. debt it holds. Massive dollar selling could follow.
Asian central banks like China's have become America's bankers, financing its excesses through good times and bad. It's now up to Asia to decide whether to extend the U.S.'s line of credit. The U.S. should be warned that the odds are moving less and less in its favor.
To contact the writer of this column: William Pesek Jr. in Kuala Lumpur, or through the Tokyo newsroom at wpesek at bloomberg.net.
To contact the editor responsible for this column: Bill Ahearn at bahearn at bloomberg.net.