x Abu Dhabi, UAEWednesday 24 January 2018

GCC losing appetite for US dollar assets

Worries about the health of the US dollar appear to be curbing the Gulf's appetite for US assets.

ABU DHABI // When Timothy Geithner, the US Treasury secretary, visited the region last week he pledged Washington's support for a strong dollar. The latest data on foreign lending to his government helps explain why. Worries about the health of the US dollar appear to be curbing the Gulf's appetite for US assets, particularly its desire to lend money to the increasingly indebted US government.

According to the latest US Treasury data, Gulf oil exporters sold a net US$940 million (Dh3.45 billion) in US long-term securities in May, the latest period available, led by a sell-off of a net $1.36bn of long-term US treasury bonds. "It will remain the policy of the United States to remain committed to a strong dollar," Mr Geithner said in an interview last week with Al Arabiya television after a two-day visit including talks with government officials in Jeddah and Abu Dhabi. The dollar, he told viewers, "will remain the principal reserve currency".

The Gulf's sell-off of US government's long-term bonds puts it alongside China and other Asian nations whose governments and investors have been trying to avoid increasing their already massive exposure to the US dollar and to US government debt. The Treasury data shows that Asian purchases for long-term US treasury bonds, after climbing to $43.7bn in March as investors fled to the perceived safety of US debt, reversed in May with a net sale of $6.2bn.

With the Obama administration having already passed a $787bn stimulus package and many economists calling for more, the US government's deficit is projected to rise to $1.7 trillion this year, swelling its overall debt to more than $12tn. That has prompted some governments, notably China's, to question the dollar's role as the world's dominant currency of trade. With slightly more than $800m in US treasury bonds, China is now the largest foreign holder of US government debt, followed by Japan.

The US has long relied on big exporting nations to finance its massive deficits. By continually lending the dollars they earn from exports to the US, Asian nations and the Gulf offset demand for their own currencies, thereby preventing them from rising and raising the cost overseas for their products. This recycling process has been the source of sporadic tension between Beijing and Washington, with the former condemning excessive US spending and the latter accusing China of a "savings glut". A host of economists and officials from both sides of the Pacific warned that these "systemic global imbalances" were unsustainable. The crisis proved them correct.

China has argued recently for the creation of a new reserve currency based on a basket of currencies and has been working to slowly increase the amount of global trade denominated in its own currency, the yuan. Still, economists say that China and other big exporters have little choice but to buy US assets. Despite slumping exports, China recently announced that its foreign exchange reserves had risen to $2.13tn. Since most global trade is conducted in US dollars and the US remains China's largest export market, China has little choice but to park its reserves in US-dollar assets, the safest of which are US government bonds.

The Gulf has perhaps even less latitude, because its currencies are largely pegged to the US dollar. Only Kuwait has jettisoned the peg, and then only in favour of a trade-weighted basket in which the dollar dominates. The pegs mean the Gulf has to move its own interest rates along with those in the US, even when their economies are moving in different directions. Last year, for example, as the US Federal reserve cut rates in a vain attempt to ward off recession, Gulf nations had to follow along, stoking accelerating inflation, runaway credit growth and a regional property bubble.

Likewise, Gulf nations have little choice, analysts say, but to put surplus oil revenues into US dollar-denominated assets. "Given the pegs, their need for dollar liquidity and dollar financing remains high," said Rachel Ziemba, an economist at RGE Monitor in New York. Ms Ziemba estimates that even after the latest sales, the Gulf's estimated $400bn in US assets has been left largely unchanged. Gulf governments and private investors still hold an estimated $140bn in US stocks and $200bn in long-term US treasuries, more than they held in the middle of last year.

Nonetheless, the May sales took place even as the region's projected oil revenues climbed along with oil prices. According to OPEC price data and production figures from the Joint Oil Data Initiative, regional oil revenues rose by more than 20 per cent in May compared with March. The May data does not, however, mean that the Gulf and Asia are pulling out of US dollar assets entirely. Analysts say that as investors sell longer-term treasury bonds - those with maturities from 20 to 30 years - they are shifting into short-term treasury bills maturing in two to 10 years, which are not captured by the Treasury data. The data do, however, include purchases of short-term bonds issued by US-backed mortgage agencies such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

After dumping these so-called agency bonds last year as the subprime mortgage crisis forced them to seek a government bailout, purchases have recovered somewhat. Asian investors bought $7.3bn in agency debt in May, up from a net sale of $2.9bn in March. Gulf purchases of agency debt also climbed, to $995m in May from just $31m in March. warnold@thenational.ae