RUSSKY BUSINESS : THE U.S. CREDIT LINE GETS CUT / BARRON´S

Thursday, June 11, 2009

UP AND DOWN WALL STREET DAILY

Russky Business: the U.S. Credit Line Gets Cut

By RANDALL W. FORSYTH

Russia's vow to swap Treasuries for IMF bonds means less credit flowing to America.

"WE WILL BURY YOU!" Soviet premier Nikita Kruschev bellowed at the West in 1956. By 1991, the Soviet Union was consigned to the dustbin of history.

Now, Russia is making noises about ending the U.S. dollar's hegemony in the international monetary affairs. Alexey Ulyukaev, first deputy chairman of Russia's central bank, said Wednesday Russia would slowly cut the amount of U.S. Treasuries in its mix of reserves.

Along with Brazil, Russia said it plans to diversify its holdings of foreign-exchange reserves from U.S. Treasuries in favor of a new bond issued by the International Monetary Fund and denominated in IMF special drawing rights.
Not coincidentally, the benchmark 10-year Treasury note briefly touched a 4% yield for the first time since last October amid continuing concern about the demand, especially from foreign creditors, for the massive supplies of securities being sold to fund the U.S. budget deficit.

The Russian central bank official's statement follows Russian President Dmitry Medvedev recent questioning of the dollar's future status as the main international reserve currency. That echoed similar sentiments by the head of China's central bank in late March ("China Makes Its Move Ahead of G20," March 27.)

China's criticism of a global system based on the dollar -- even as U.S. deficits explodes and floods the market with trillions of Treasury obligations -- comes across as perceptive and well-reasoned. But hubris, no doubt a byproduct of becoming America's largest creditor, was betrayed recently when a group of students in Beijing openly laughed at Treasury Secretary Timothy Geithner's statement that U.S. debt was a safe investment.

Russia's tone is more bellicose (surprise, surprise) in asserting the need for a substitute for the dollar. That belies the continuing crisis in Russia's own economy, which for the time being is being covered up by the rebound in crude oil prices to $70 a barrel, which has sent the Russian stock market and the ruble soaring this year (not unlike other emerging-market bourses and currencies.)

But last year and early this year, at the height of the international financial crisis, Russia had to spend billions of its currency reserves to prop up the ruble as crude crashed as low as $35. And with its own stimulus program totaling close to 10% of gross domestic product and double-digit inflation, Russia is no position to lecture anyone about fiscal profligacy.

Indeed, it is likely that at some point Russia will have to draw on its $400 billion in currency reserves to fund its own needs. By contrast, the other members of the BRICs -- Brazil, India and China, will probably continue to amass foreign exchange.

But,as the Wall Street Journal points out in its Thursday editions, the desire of the BRICs to invest their cache of reserves in SDR-denominated IMF bonds reflects politics more than economics.

The purchase by Brazil and Russia of $10 billion worth of IMF securities would give those countries greater clout, especially in development matters. That $10 billion would do little to diversify their currency holdings, however.

Moreover, the use of SDR investments is a tacit admission that no real substitute has been found for the dollar. The euro has gained market share in international reserves, although the yen has not made significant inroads.

Indeed, the greenback's great advantage has been dollar-based credit markets, which provide unequaled investment opportunities and liquidity. That, ironically, may wind up being the dollar's ultimate downfall.

America has exploited that advantage by borrowing and living beyond its means for decades. The whole world wanted dollar assets, so we accommodated that demand by borrowing seemingly without limit, both in Washington and across the country. Wall Street grew rich by creating new instruments to facilitate the borrowing, and then by distributing the paper around the world. Opaque derivative instruments leveraged the amounts, and the profits.

This proposed move to SDR-based IMF bonds by the BRIC countries is one more step away from the dollar-centric system that has created the paper wealth, which is now evaporating.

The world, in essence, is cutting America's credit line. And, notwithstanding the inflation hysteria about Treasury borrowing and the Federal Reserve's balance sheet, this reluctance of foreign creditors to continue acquiring dollars and lending to the U.S. is profoundly deflationary.