Russia deals fresh blow to greenback

U.S. currency falls to 15-month low; Russian central bank plans to add loonie to reserves

The rebellion against the U.S. dollar is gathering force, catching Canada up in a slow but steady march across the globe.

In the latest blow to the greenback, Russia's central bank has signalled its intention to add the Canadian dollar, and possibly one or two other currencies, to its foreign exchange reserves – the third-largest in the world – as it seeks to cut its huge exposure to the fading U.S. currency. That revelation by a senior Bank Rossii official in Moscow triggered a sharp gain for the loonie Wednesday and contributed to the U.S. dollar's slide to a 15-month low.

The loonie ended the trading day at 95.65 cents (U.S.).

The Canadian dollar is in the sights of foreign central bankers, partly because of Canada's relatively sound fiscal position and the perception it is a commodity-based currency, analysts say. And there are not many other options once a central bank decides it is holding more than enough U.S. dollars and euros. Such a shift brings Russia into line with the currency diversification strategies being weighed or launched by China, Indonesia and a handful of other major central banks holding vast amounts of U.S. Treasuries.

While Russia's move may be a vote of confidence in Canada, even a minor rejigging of foreign reserve holdings by central banks in favour of the loonie could have dramatic consequences for the Canadian currency and the economy, which is struggling to recover from the recession.

A stronger dollar hurts export-dependent industries whose goods become more costly as the currency rises.

Canada's currency accounts for a mere 4.2 per cent per cent of daily global currency turnover. If as little as 3 per cent of the $7-trillion (U.S.) in global foreign exchange reserves – or $200-billion – were somehow shoehorned into Canadian dollar assets, the loonie “would look like a flashlight bulb connected to a nuclear power generator,” said investment banker Ken Courtis, a Canadian expatriate based in Asia.

Analysts, however, do not at this point expect a surge in demand for Canadian dollars as a result of the Russian statement.

“This is a very short-term thing,” said Beat Siegenthaler, chief emerging-markets strategist and currency watcher with TD Securities in London. “In three days, it will be forgotten. Even in one day.”

About 55 per cent of Russia's foreign currency reserves, the equivalent of more than $430-billion (U.S.), consists of U.S. dollars and much of the rest is in euros. The central bank also has small, undisclosed positions in Japanese yen and British pounds.

Rather than selling down U.S. dollars, central banks are looking for ways to diversify by adding other currencies as their reserves grow. And moving out of U.S. dollar assets is easier said than done, because no other market in the world comes close to the size, depth and liquidity of U.S. Treasuries.

“It's not so easy to replace that,” Mr. Siegenthaler said.

“You may be more comfortable with another currency, but there's no other market that gives you the same ease of trading.”

And in the case of the Russian bear, it may be typical Kremlin gamesmanship at work, some analysts suggested.

“It may be just a way of trying to lower the role and profile of the United States across the board,” said currency specialist David DeRosa, president of DeRosa Research of New Canaan, Conn.

“It's mostly just a symbolic thing. The Russians are trying to put pressure on Obama.”

But if it turns out to be more than a political chess move by a government eager to reclaim lost prestige on the world stage and if China and other major central banks follow through on their own diversification plans, there is nothing symbolic about the damage it would inflict on the U.S. dollar.

And there is no denying that the long-term trend toward currency diversification is acquiring more urgency over growing worries that soaring U.S. government deficits will eventually trigger a nasty bout of inflation. That, in turn, would severely erode the value of dollar holdings in central bank coffers around the world.

“There's no sign of inflation right now,” Mr. DeRosa said. “But if you are a foreign central bank holding a lot of U.S. dollars, you should be concerned about whether or not the dollar is going to be destroyed by future inflation.”

Meanwhile, though, central banks and other institutions are still coming to the table for U.S. Treasuries. Foreign buyers, for example, have accounted for about half the seven-year bonds made available in the past five government auctions – amounting to nearly $14-billion.

Indeed, U.S. Federal Reserve data show that foreign central banks are actually increasing their dollar holdings.

“Of course, these countries have continued to accumulate reserves over the last few months,” Mr. Siegenthaler said. “So it's a question of whether the U.S. gets a bit less of new flows. The net effect may still be additional inflow [of U.S. dollars].”

If the Russians are serious about adding loonies to their currency holdings, it will be difficult to judge their timing.

“Like any central bank, for them to announce it, they may have already started doing it,” said David Bradley, director of foreign-exchange trading at Scotia Capital.

Wednesday's developments came as the Bank of Canada prepares for its next pronouncement on interest rates on Dec. 8. The central bank has repeatedly warned that a strong currency will curb growth.

Further moves to diversify away from the U.S. dollar will bolster the Canadian currency, Royal Bank of Canada said in a report.

“The size and timing of Canadian-dollar buying by either the Bank of Russia, or any other central bank for that matter, remain unclear and will probably never be fully known,” said Matthew Strauss, senior currency strategist.