Re: Federal Budget Deficit Expected to Reach Over $300 Billion Next

["Dr. Bruce R. McFarling" <Bruce.McFarling@xxxxxxxxxxxxxxxx>]

On Thu, 23 Jan 2003 15:41:07 -0500,
"Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx> wrote:

>It is more than psychology.  The current account settlements
>are indeed done in three major currencies, dollar, euro and
>yen, not in equal quantities but with rising amounts in euros
>and yen. Many centrl banks adjust their reseerves denominations
>in relation to their economy's trade relations. The issue is
>on excess reserves, which are predominantly denominated in
>dollars.  Foreign exchange reserves are the high power money
>of high power moneys (domestic bank reserves).  Some 65% of
>the world reserves is dennominated in dollars.  It has been
>falling, but still high in term of the proportion of US trade
>in world trade.  Under Bretton Woods, 100% of the world's
>reserve currency was denominated in dollars, but then the
>dollar was fixed to gold at $35 per ounce.  The US GDP is
>only 12% of Gross World Product on a purchasing power parity
>basis.  The dollar should not be more that 15% of the world's
>reserve currencies.  The excess 50% is politically based and
>gives the US the privilege of a hidden tax on the rest of the
>world.

>Now the role of reserves is to anchor the value of a currency,
>either at fixed exchange rates or floating rates.  Reserves in
>non-dollars carry a higher risk of illquidity, that is if a
>particular country holds an excessive amount of euros and it
>is already buying all it needs from euroland, then its euro
>reserves becomes less liquid or useful and will incur a cost
>to the holder who tries to use it when in need.  Now basic
>commodities such as oil, is most liquid, which in turn makes
>the dollar liquid.

The critical step in this reasoning is that a country
can be "already buying all it needs" from the euroland,
at the same time that is has a current need for liquidity.

Now, for an oil supplier, that need that cannot be
satisfied in euroland isn't oil.  If it is one of
the smaller population oil suppliers that have
persistent net capital outflows, that need cannot
be debt service.  And given the net capital outflows,
its oil earnings on a current basis are meeting any
current imports in dollar terms, which a healthy
amount left over.

So for that case, I don't see anything standing in
the way of 40/40/20 USD/EUR/JPY reserves, or even
0/70/30 USD/EUR/JPY reserves, except psychology.

How many years of exchange losses on USD reserves
when viewed in terms of a USD/EUR/JPY basket will
it take to erode the psychology of valuing the
reserves on USD alone (which defines away exchange
losses on USD reserves)?