Further predictions of secular dollar weakness, from a portfolio balance perspective
From Reuters, a slightly different take on how portfolio balance effects can work:
Asian central banks are huge holders of Americans’ precious dollars and major bankrollers of the U.S. current account and trade deficits. The fear that they will shift more of their reserves into other currencies is ever-present.
Meanwhile, at the end of last year, total money under management in the United States was $17.7 trillion, according to data from the Bureau of Economic Analysis — six times the total official reserve holdings of the major Asian central banks, which stood at roughly $2.89 trillion as of May.
“I really don’t believe the Asian central banks are the thing to fear here, because they want stability,” said Michael Woolfolk, senior currency strategist at the Bank of New York. “That’s one of the reasons why they intervene as heavily as they do and have the assets they do.”
MORE U.S. INVESTORS LOOK OVERSEAS
Almost 40 percent of U.S. funds expect to make a “significant” asset-allocation change over the next three years, according to financial-services research group Greenwich Associates in Greenwich, Connecticut.
The survey found that many funds expect both to increase allocations to the type of foreign investments they already hold and to seek other opportunities.
:But Greenwich Associate’s Webster said the U.S. institutional community tends to adopt a much longer-term view, and even another string of U.S. rate rises is unlikely to reverse the ongoing shift into international waters.
While I find the the article’s thesis that central bank reserves are not central a bit overstated (after all, central banks can act in a unilateral or coordinated fashion that private agents can’t), the observation that private investors are ready to diversify out of dollar assets of interest.
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reserve accumulation,
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dollar downtick—->high rates—–>housing debacle—>consumption fall—>asian exports fall—->recession—->deflation—>lower interest—->more lower interest—>low inflation (2020)
Asset values change at the margins, not due to bulk holdings. The question is what is the nature of the buying and selling—not what is already held. This is one of the most elementary and common mistakes of pundits.
Specifically: most money in the US isn’t likely to move to other currency zones, therefore is unlikely to have an impact on the exchange rate. Conversely, most foreign central bank dollar holdings are susceptible to reallocations, which would inherently have an impact on the exchange.
There’s a very relevant contemporary analog: most money in the housing market isn’t held in “exotic” mortgages, but a huge quantity, if not most, recent mortgages are of this nature, having a major effect on home price inflation. As these vulnerable holdings become exposed, so do home prices, in proportion.
Aaron Krowne: I understand the point of marginal versus average. But I take the “Almost 40 percent of U.S. funds expect to make a ‘significant’ asset-allocation change” as those being close or at the margin; in other words, in a graph of the risk premium (or “excess returns”) against asset share, the slope is very flat. Hence, small changes in expected returns can induce big changes — all within a mean-variance optimization framework consistent with margins being important see this [pdf] for details).
Menzie: I think we agree (my original post was not intended to be a criticism of you).
Aaron Krowne: Thanks for the clarification. Apologies if the response came across as a rebuttal. But I do think you’ve made a good point that one needs to distinguish between stocks and the sensitivity of those stocks to changes in expected returns (as well as to risk aversion).