EU

[Moderator]

Еврозона

[Moderator]

• Diversification Alternatives
• Not The Dollar’s Rescue Package
Reserve diversification is the new buzz in the market. To the surprise of many traders, the People’s Bank of China, recently released
figures indicating that China has reduced holdings of US dollars in their reserves by 6% over the past 2 years (from 82% to 76%). In
the past, reports have only highlighted China’s continual purchases of US treasuries and in fact, next week’s US Treasury International
Capital flow data should confirm just that. Although China continues to purchase US treasuries to maintain the Yuan’s peg against the
dollar, the latest report suggests that they are at the same time also quietly increasing their purchases of euros. The Chinese tend to
be very secretive and conservative therefore it comes as no surprise that they do not provide the details on the composition of their
reserves. However, based upon their mixture of exporting activities (as indicated in the image), China must be accumulating not only
dollars and euros, but also Japanese yen. This trend, which we are sure is not unique to just China will be a major factor that weighs
on the dollar throughout 2005. The reserve diversification buzz has already played a major role in helping the EURUSD rally 5.4% over
the past month.
Yuan Revaluation – Euro’s Big Moment?
As China moves towards pegging the CNY to a basket of currencies or floating the Yuan, there could be a notable impact on the Euro.
China is the world’s second largest holder of US Treasury debt, approximately $191 billion second only to Japan and the Eurozone. A
revaluation of the Yuan will force Chinese policy makers to sell a least part of their US dollar holdings and buy euros and/or yen. With
the growing shift by different countries to diversify their foreign exchange reserves away from dollar to include an increasing amount of
euros, this could be the single currency’s big moment. So far we know that Russia will be readjusting their dollar denominated reserve
holdings, South Africa and India are also suspected of dumping US treasuries while South Korea and Japan seem to be considering
reserve diversification behind the scenes.
Refco, LLC assumes no responsibility for errors, inaccuracies or omissions in these materials. Refco, L.L.C. does not warrant the accuracy or completeness of the
information, text, graphics, links or other items contained within these materials. Refco, L.L.C. shall not be liable for any special, indirect, incidental, or consequential
damages, including without limitation losses, lost revenues, or lost profits that may result from these materials. Opinions and estimates constitute our judgment and are
subject to change without notice. Past performance is not indicative of future results.

Japan appears to be playing the same games that the US is playing. On the surface, the Japanese government has been saying that
they are not considering changing their reserve allocations, but behind the scenes, there is mounting evidence that this is a major topic
of discussion. This sort of artificial solidarity is nothing but an exercise of diplomacy on behalf of Asian countries that do not want to
cause a major currency crisis. A sharp fall in the dollar will not only hurt the US, but also their own economies. The US is the biggest
customer for most of these countries, therefore a sharp fall in the dollar will crimp US consumer spending which boils down to the US’
export demand. Meanwhile according to the latest Bank of International Settlements report, oil exporters have been reducing their
dollar holdings over the past 3 years. Central banks in the Middle East have exchanged some dollar reserves for euros to avoid
incurring losses related to the slide in the dollar. Although the euro was only launched in 1999, it has since become the world's second
most popular reserve currency. As time passes, we expect more central banks to hold an increasing number of euros as they adjust
their reserve holdings to reflect their trade flows. For China, their mix will continue to include the dollar, but by a diminished capacity.
However, they are also expected to increase their holdings of Japanese yen and the euro.
With increasing pressure to revalue the Yuan, China could choose one of four options:
Free-float (Least Likely)
A free float is the least likely scenario because it could potentially be very dangerous since a free-float would prompt speculators to
flood the markets, which can easily result in exchange rate overshooting. Ask anyone and they will agree that the Yuan would only
head in one direction (up) if it were allowed to float freely. Additionally, since import and exports represent a high percentage of China’s
GDP, a free float is nearly impossible. China knows that speculators will push the Renminbi to excessive levels, threatening exports,
which have been the foundation for the strength of their economy. With unemployment hovering around 15%, and joblessness rising,
China cannot afford to introduce such large business risk to its manufacturing sector.
Furthermore, a free float is not necessarily good for the US. China is a large owner of US treasuries. They have accumulated foreign
exchange reserves in excess of $500 billion. They are currently the second largest purchasers of US treasuries, next to Japan. Hence,
they play a pivotal role in keeping US interest rates low, supporting the US recovery. If China floats their currency, they will no longer
need to accumulate foreign exchange reserves at such an aggressive pace. In fact, their demand for US Treasuries will fall
significantly, which could lead to a back-up in long-term US interest rates and hence, cause a collapse in the bond market, jeopardizing
the US recovery.
Pegging to a basket of currencies (Possible)
The People’s Bank of China has suggested several times that it is considering pegging the Yuan to a basket of currencies. The latest
report from the central bank further confirms that China could very well choose this option. Under such a system, the Yuan would be
fixed to a mix of foreign currencies, weighted according to the issuing country or region’s trade volume with China. This would allow for
some flexibility against the dollar and discourage any one-way speculative bets. Most importantly, it would represent a more proper
value for the CNY. It would also make China less sensitive to one country’s monetary policy. By pegging the Yuan to the dollar, China
has basically foregone all monetary power to the US Federal Reserve. With a basket of currencies, China would be able to juggle the
weight of each currency so as to obtain a mix more in line with its monetary goals. The Japanese yen and Euro would benefit most
directly by such re-weighting since along with the US, they represent China’s most important trading partners.
Pegging the Yuan to a higher rate or Widening Trading Band (Most Likely):
The most likely scenario is that China will gradually widen the trading band for the Renminbi. China is grappling with political pressures
and may be compelled to appease their critics with a marginal compromise. Political pressure has only intensified in recent months,
with a bipartisan group of Senators calling for a 27.5% tariff on all products from China to force a revaluation. Europe, Japan and the
US have already imposed marginal restrictions and tariffs on certain Chinese imports. We expect China to be comfortable with at least
a 1%-5% revaluation, but by no means will China allow for a 40% appreciation in the Renminbi in one year. Also, a moderate
revaluation will not significantly hurt exports. Foreign corporations have invested billions of dollars in partnering with local firms or
building factories in China. A modest revaluation may not be a good enough reason for these firms to shift outsourcing to other
countries. A hint that this scenario may be their preferred choice comes from an unconfirmed statement by a “local monetary source”
that China is planning a 30% revaluation of the Renminbi over the next five years.
Refco, LLC assumes no responsibility for errors, inaccuracies or omissions in these materials. Refco, L.L.C. does not warrant the accuracy or completeness of the
information, text, graphics, links or other items contained within these materials. Refco, L.L.C. shall not be liable for any special, indirect, incidental, or consequential
damages, including without limitation losses, lost revenues, or lost profits that may result from these materials. Opinions and estimates constitute our judgment and are
subject to change without notice. Past performance is not indicative of future results.

Yuan Revaluation – Not the Rescue Package For the US Dollar
The recent buzz from the Fed and the US manufacturing industry has been pinning the blame for the US trade deficit on China’s
undervalued currency, accusing them of stealing jobs and dumping goods. Although some of the claims are true to a certain extent, a
Yuan revaluation would certainly not be the rescue package that saves the dollar from its recent troubles. The core problem for the US
dollar is the extravagant spending behaviors of US consumers and the US government. The US budget deficit ballooned to a record
$113.9 bln in February from $96 bln. With the Social Security proposal possibly costing as much as $1 trillion to set up and the
prospect of continued military outlays due to rising tensions with North Korea, Syria and Iran, the deficit is only expected to widen even
further in the near term. In the month of January, consumer credit rose 11%, which were double expectations. The surprising jump
highlights the liberal spending habits of US consumers whose debt levels are at all-time highs. Although January tends to be a
seasonably strong month for credit and charge card usage, optimism around lower oil prices are sure to have boosted the spending
appetite of US consumers. The over-consumption by US consumers is one of the Fed's gravest concerns. In boosting interest rates,
they hope to increase the attractiveness of savings in the US. The great big imbalance story in the global economy that is keeping the
dollar under water is that the US is the home to notorious spenders whereas Asia, namely Japan is the home of notorious savers. In a
nutshell, unless US consumers learn to save more and Asian consumers learn to spend more or are tempted to do so by their
respective central banks, the imbalance will continue to be a major issue crippling the US dollar.

[Moderator]

http://specials.ft.com/euro/FT3Y7D0D1PC.html#a