The dollar hiccups again

Throughout the mid and late nineties, U.S. Treasury secretaries learned to repeat the mantra that “a strong dollar is good for America” ad nauseum to reporters — because if they didn’t, the markets would speculate that the dollar wouldn’t be defended and start to go nuts. Through the mid and late noughties [Is that what ...

By , a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University and co-host of the Space the Nation podcast.

Throughout the mid and late nineties, U.S. Treasury secretaries learned to repeat the mantra that "a strong dollar is good for America" ad nauseum to reporters -- because if they didn't, the markets would speculate that the dollar wouldn't be defended and start to go nuts. Through the mid and late noughties [Is that what this decade is called?--ed. Damned if I know] it's not really going to matter a whole hell of a lot what the U.S. Treasury Secretary says. What matters now is what officials are saying in the countries where official institutions are buying dollars and dollar-denominated assets -- Japan, China, Korea, etc. And as this Financial Times story suggests, the quicker these officials learn not to publicly discuss "diversification," the less jittery currency markets will be:

Throughout the mid and late nineties, U.S. Treasury secretaries learned to repeat the mantra that “a strong dollar is good for America” ad nauseum to reporters — because if they didn’t, the markets would speculate that the dollar wouldn’t be defended and start to go nuts. Through the mid and late noughties [Is that what this decade is called?–ed. Damned if I know] it’s not really going to matter a whole hell of a lot what the U.S. Treasury Secretary says. What matters now is what officials are saying in the countries where official institutions are buying dollars and dollar-denominated assets — Japan, China, Korea, etc. And as this Financial Times story suggests, the quicker these officials learn not to publicly discuss “diversification,” the less jittery currency markets will be:

Japan’s finance ministry moved swiftly on Thursday to calm markets after the dollar tumbled and Treasury yields spiked higher on comments made by Junichiro Koizumi, prime minister, about diversification of foreign currency reserves. Asked by a parliamentary committee about government policy on Japan’s $840.6bn of foreign reserves, Mr Koizumi said: “I believe diversification is necessary.” Markets reacted sharply to his comments, sending the euro to a two-month high of $1.3456 against the dollar. Ten-year Treasury yields reached a seven-month high at 4.57 per cent on the news. Japan holds large amounts of Treasuries as a result of its currency interventions and any diversification of its reserves is likely to involve scaling back its holdings. Investors fear this would weaken bond prices and lift yields, raising US borrowing costs. Peter McTeague, strategist at RBS Greenwich Capital, said trading volumes of US Treasuries jumped and investors suffered “a pretty wild ride” in Asian trading hours. Japan’s ministry of finance (MoF) moved quickly to quash any suggestion that policy had changed. Mastatsugu Asakawa, director of the foreign exchange division at the ministry, denied Japan’s policy had shifted. “We have never thought about currency diversification,” he said, saying the prime minister was referring to asset-class diversification within a particular currency…. The episode however emphasised market sensitivity to any hint that Asian central banks are considering diversifying their massive dollar holdings, which have built up as a result of unprecedented levels of intervention in the past two years.

This is essentially a replay of what happened with South Korea last month. My guess is that we’ll see a few more gaffes and then officials will wise up — as long as Bretton Woods 2 sticks around.

Daniel W. Drezner is a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University and co-host of the Space the Nation podcast. Twitter: @dandrezner

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