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Business Headlines For October 9, 2009

Asian Markets Trade Mixed

By Shani Raja

Oct. 9 (Bloomberg) — Asian stocks rose, with the MSCI Asia Pacific Index set for its biggest weekly gain in a month, as investors favored companies linked to the global economic recovery over haven assets.

Samsung Electronics Co., the world’s No. 1 memory-chip maker, climbed 4.9 percent after chip prices rose to a 16-month high. Record gold prices drove Zijin Mining Gold Co. up by 10 percent in Shanghai, where markets traded after an eight-day holiday. Electric Power Development Co. sank 2.4 percent in Tokyo, leading declines by utilities. Treasuries fell after Federal Reserve Chairman Ben S. Bernanke said the bank is ready to tighten monetary policy once the economy improves.

The MSCI Asia Pacific Index rose 0.2 percent to 118.84 at 5:10 p.m. in Tokyo, having swung between gains and losses at least 16 times. Two stocks advanced for each one that declined. The index has climbed 4 percent this week as a report showed U.S. service industries expanded and signs of growth prompted Australia to raise interest rates.

“We’re all hoping the global recession is winding to a close,” said Rob Patterson, who helps manage $3.4 billion at Argo Investments Ltd. in Adelaide, Australia. “Certainly, the economic indicators are getting less worse. But I don’t imagine the U.S. will be raising rates any time soon.”

China’s Shanghai Composite Index climbed 4.8 percent, leading gains in Asia, while Taiwan’s Taiex Index added 0.9 percent. South Korea’s Kospi Index rose 1.9 percent…..

European Markets Trade Down

By Daniela Silberstein

Oct. 9 (Bloomberg) — European stocks and U.S. index futures fell as Federal Reserve Chairman Ben S. Bernanke said the central bank will be ready to raise interest rates when the economic outlook “has improved sufficiently.”

Xstrata Plc, the world’s fourth-biggest copper producer, and Antofagasta Plc dropped more than 2 percent as metals prices retreated. Samsung Electronics Co. climbed 4.9 percent in Seoul, leading gains by Asian shares, as chip prices increased to a 17- month high.

Europe’s Dow Jones Stoxx 600 Index slipped 0.4 percent to 242.54 at 11:06 a.m. in London, trimming this week’s gain to 3.6 percent. The gauge has dropped 1.4 percent from this year’s high on Sept. 17 as data on U.S. unemployment, manufacturing and consumer confidence missed economists’ forecasts, fueling concern that the global economic recovery may not be robust.

“An increase in interest rates in an insecure environment is not welcome and the market did not want to hear that,” said Gerold Kuehne, who manages $127 million at LLB Asset Management AG in Vaduz, Liechtenstein. “We saw last week that economic data is still not positive. It’s a bumpy road to recovery.”

Standard & Poor’s 500 Index futures lost 0.3 percent today. The benchmark measure for U.S. equities has climbed for four straight days, the longest streak in a month, as Alcoa kicked off the earnings season with results that beat analysts’ estimates and jobless claims decreased more than forecast. The MSCI Asia Pacific Index advanced for a fourth day, increasing 0.4 percent.

Oil Trades Unch. @ $71pb

By ALEX KENNEDY p {margin:12px 0px 0px 0px;}

SINGAPORE (AP) – Oil prices hovered above $71 a barrel Friday in Asia as the U.S. dollar rebounded.

Benchmark crude for November delivery was down 39 cents at $71.30 by late afternoon Singapore time in electronic trading on the New York Mercantile Exchange. The contract added $2.12 to settle at $71.69 on Thursday.

Oil has bounced in a range between $65 and $75 for months amid signs a recovery of the U.S. economy could be slow and uneven.

A weakening dollar has helped support crude prices as investors pour money into commodities on concern that the surge in stimulus spending will eventually spark inflation.

“People are using crude and gold as an inflation hedge because the U.S. is just printing money,” said Clarence Chu, a trader at market maker Hudson Capital Energy in Singapore. “There’s definitely been a negative correlation between the dollar and oil.”

The euro fell to $1.4743 on Friday from $1.4791 the previous day, and the dollar rose to 88.85 yen from 88.37.

Oil prices will likely trade near $70 until there are more positive economic signs, such as job creation, Chu said.

“There hasn’t been a strong signal that the economy is recovering,” Chu said. “There are still job losses every month.”

The U.S. unemployment rate rose to 9.8 percent in September, the highest since 1983.

In other Nymex trading, heating oil fell 0.85 cents to $1.84 a gallon. Gasoline for November delivery dropped 0.52 cents to $1.77 a gallon. Natural gas for November delivery slid 1.7 cents to $4.95 per 1,000 cubic feet.

In London, Brent crude fell 34 cents to $69.43 on the ICE Futures exchange.

Dollar Rises Against Most Major Currencies

By Justin Carrigan

Oct. 9 (Bloomberg) — The dollar rose against the yen and the euro and government bonds fell after Federal Reserve Chairman Ben S. Bernanke said the bank will tighten monetary policy once the economy improves. Commodities slipped.

The U.S. currency advanced as much as 1.2 percent versus the yen, the most since Aug. 7, and was up 0.5 percent at 11:20 a.m. in London. Yields on two-year Treasuries and German notes jumped as much as eight basis points. Copper fell 1.1 percent. Futures on the Standard & Poor’s 500 Index declined 0.2 percent.

The Fed will need to raise rates “at some point” to control inflation, Bernanke said at a Board of Governors conference yesterday in Washington. Australia’s Reserve Bank unexpectedly increased its key rate Oct. 6. The MSCI World Index of 23 developed stocks has advanced 4.4 percent this week as U.S. jobless claims fell more than analysts estimated and Alcoa Inc. reported an unexpected profit.

Bernanke’s remarks “were interpreted to suggest that the Fed stood ready to tighten,” Gareth Berry, a currency strategist at UBS AG in Singapore, wrote in a note today. “The comments come as investors look for evidence that the policy tightening timetables of other central banks will be brought forward” after the Australian move.

The Dollar Index, which IntercontinentalExchange Inc. uses to track the currency against the yen, euro, Swiss franc, pound, Swedish krona and Canadian dollar, rose 0.3 percent to 76.198. It fell to 75.767 yesterday, the lowest level since August 2008.

Yen Drops

The yen fell against 13 of the 16 most-traded currencies tracked by Bloomberg, losing 0.5 percent versus the dollar, after Japan’s Cabinet office said machinery orders rose 0.5 percent in August, compared with the 2.1 percent increase predicted in a Bloomberg survey of 27 economists.

The increase in the German two-year yield narrowed the gap, or spread, with the 10-year bund by three basis points to 184 basis points, the lowest level since May 1, based on closing prices. The U.S. Treasury spread also narrowed two basis points, to 234 basis points.

Copper for delivery in three months fell as much as 1.4 percent on the London Metal Exchange, leading a decline in industrial metals. Crude oil slipped 0.5 percent to $71.35 a barrel in New York trading. Gold for immediate delivery declined 0.6 percent to $1,048.55 an ounce. The metal rose to a record for three consecutive days this week…..

Wynn Macau IPO Has A Smashing Open

INFY Rallies 7.7% on Better Than Expected Earnings

By Harichandan Arakali

Oct. 9 (Bloomberg) — Infosys Technologies Ltd., India’s second-largest software exporter, reported second-quarter profit rose 7.7 percent, beating analysts’ estimates, after winning more business from its customers.

Net income increased to 15.4 billion rupees ($332 million), or 26.83 rupees a share, in the three months ended Sept. 30, from 14.3 billion rupees, or 24.97 rupees, a year earlier, Bangalore-based Infosys said today. That beat the 14.9 billion rupee median of 15 analyst estimates compiled by Bloomberg.

Chief Executive Officer S. Gopalakrishnan reduced prices to retain business from customers in the U.S. and Europe, his largest markets, amid the worst recession since the 1930s. Infosys won orders from Australia’s Telstra Corp. and the U.K.’s BP Plc after the two clients sought to decrease the number of suppliers to cut costs.

“It is a very positive result; the environment is getting much more stable,” said Vaibhav Sanghavi, a director at Ambit Capital Ltd. in Mumbai, who manages funds for wealthy individuals. “We are in for a little uptick; things have stabilized and margins will improve from these levels.”

U.S. technology demand will begin to increase in the three months ending Dec. 31, followed by a global recovery in 2010, research firm Forrester Inc. said last month. White House adviser Lawrence Summers said yesterday there has been a “substantial return to more normal conditions” in the U.S., and cited economists’ estimates that the world’s largest economy returned to growth in the third quarter.

Raises Forecast……

GE Expects To Sell Assets As African Oil Fields Come On Line

By Andres R. Martinez

Oct. 9 (Bloomberg) — GE Oil & Gas, a subsidiary of General Electric Co., expects to boost sales this year and next as oil producers develop new fields in China, Africa and Australia, unit Chief Executive Officer Claudi Santiago said.

The maker of turbines and generators for the oil and natural-gas industry may boost sales this year to between $7.5 billion and $8 billion, Santiago said, without providing 2008 sales figures.

“We expect growth in the single digits this year that will come fundamentally from active markets like China and Africa,” he said yesterday in an interview in Buenos Aires. The unit expects a “renaissance in LNG next year, especially in Australia.”

The unit recently signed a service contract with Chevron Corp. for the Gorgon field, a $37 billion gas project off northwest Australia, Santiago said. GE will also try to win contracts for turbines and generators from Petroleo Brasileiro SA, as the Brazilian state-controlled company prepares to tap deepwater deposits, he said.

Oil service companies such as Schlumberger Ltd. and Halliburton Co. have seen a drop in sales as Chevron, Exxon Mobil Corp. and other producers slash capital-expenditure budgets after oil prices plunged by more than half since reaching a record $147.27 a barrel in July 2008.

Technical Analysts Site A Rising Wedge Pattern in Asian Markets

By Jonathan Burgos

Oct. 9 (Bloomberg) — The emergence of a “rising wedge pattern” may trigger a slump of as much as 20 percent for the MSCI Asia excluding Japan Index, according to technical analysis by CLSA Asia Pacific Markets.

A rising wedge pattern refers to a trading range on a chart that begins wide at the bottom and contracts as prices move higher. The MSCI gauge has been climbing in that pattern since June 1 when it broke through the 400 level for the first time since September 2008, according to data compiled by Bloomberg.

The index added 0.6 percent to 463.29 as of 12:24 p.m. in Hong Kong. Speculation of a global economic recovery has driven the measure up by 89 percent in the past seven months.

“A rising wedge pattern is ultimately a bearish development as it represents poor momentum, which is highlighted by the bearish price/momentum divergence on the daily chart,” Laurence Balanco, a Hong Kong-based analyst with CLSA Asia Pacific Markets, wrote in a note dated yesterday. “A break below the lower boundary of the pattern would suggest a move back to the base of the pattern – in this case 370.”

“The first sign of technical weakness would be a break below the 440 and 445 range,” he said.

Telefonica Raises Divi & Backs Guidance

By Charles Penty and Javier Marquina

Oct. 9 (Bloomberg) — Telefonica SA pledged a 22 percent dividend increase next year and repeated its 2010 earnings forecast as Europe’s second-largest phone company sought to reassure investors of its profit prospects amid the recession.

The Spanish company, which this week made a $3.7 billion bid for Brazil’s GVT (Holding) SA, said in a filing to regulators today that it will achieve earnings per share of 2.10 euros next year and will propose a dividend of 1.40 euros a share. Telefonica, which is hosting a meeting with investors at its Madrid headquarters today, will also target a dividend of at least 1.75 euros a share in 2012, the company said.

Chairman Cesar Alierta is offering a higher payout to assuage concern that growth will slow amid a shrinking economy at home — with Spain mired in its worst recession in 60 years – – and other markets including the U.K. The company will seek average annual revenue growth of 1 percent to 4 percent through 2012 and seek to boost its customer base by at least 27 percent to more than 320 million, Telefonica said.

“The news on the dividend is very positive,” said Alberto Espelosin, who helps manage about $10 billion at Zaragoza, Spain-based Ibercaja Gestion. “It’s important information that will help investors determine a value for the shares.”

Shares climbed as much as 2.3 percent and traded 1.8 percent higher at 19.565 euros at 9:32 a.m. in Madrid, valuing the company at 92 billion euros ($135.5 billion). The stock has risen 23 percent this year compared with a 29 percent gain in the IBEX 35 stock index in Madrid…..

France & Italy’s Industrial Output Rises

y Mark Deen and Lorenzo Totaro

Oct. 9 (Bloomberg) — French and Italian industrial output surged in August, fueled by government incentives to buy new cars, adding to signs that stimulus spending is helping the euro-region economy emerge from its worst recession in 60 years.

French output rose 1.8 percent, from July, dwarfing the 0.3 percent median forecast by 22 economists surveyed by Bloomberg. Italian production jumped 7 percent in August, the biggest monthly increase in at least 20 years.

The gains in manufacturing in France and Italy, which account for more than a third of the euro-region economy, provide further evidence that the euro region will expand in the three months through September, after five quarters of contraction. European manufacturing also grew more than initially estimated in September, a report showed this week.

“Manufacturing activity will finally stop being a drag on growth in third quarter,” said Annalisa Piazza, an economist at Newedge Group in London. “Today’s data, coupled with the upswing in German industrial production in August, will lead to an upswing in euro-zone output figures in August of around 3 percent month on month, much stronger than previously anticipated.”

The euro-area economy barely contracted in the second quarter as Germany and France, the region’s largest economies, returned to growth. The euro area will expand 0.3 percent in 2010, the International Monetary Fund said on Oct. 1, when it trimmed its estimate for this year’s contraction to 4.2 percent…..

MON Faces Justice Department in Antitrust Case

Monsanto Co. said Thursday that it has received requests from the U.S. Department of Justice “in recent months” over whether or not the seed giant has violated antitrust laws.

The inquiries at the St. Louis-based company, the biggest maker of genetically modified seeds, come as the Justice Department says it plans to scrutinize competition in many sectors of the agriculture industry, including seeds, dairy and meat. In August, the Department of Agriculture and the Justice Department held the first of what is to be a series of workshops across the country to explore competition issues in the agriculture industry.

Christine Varney, chief of the Justice Department’s antitrust division, said recently that “competition issues affecting agriculture have been a priority for me.”

A Monsanto spokesman characterized the nature of the Justice Department’s questions as “business as usual” and “similar to the requests we’ve received from time to time over the last few years.”

A spokeswoman for the Justice Department declined to comment…..

Bernanke Sees Tighter Policies As Economy Heals

By Mark Felsenthal

WASHINGTON (Reuters) – The U.S. Federal Reserve must continue to prop up the economy for an extended period but can’t do so indefinitely for fear of triggering an inflationary surge, Federal Reserve Chairman Ben Bernanke warned on Thursday.

The U.S. central bank has cut interest rates to near zero percent and pumped hundreds of billions of dollars into the financial system to counter the worst financial crisis since the Great Depression.

At a Fed conference, where he discussed the central bank’s ballooning balance sheet, Bernanke made clear that policymakers were thinking how to terminate support as recovery sets in.

“Accommodative policies will likely be warranted for an extended period,” Bernanke told participants at the conference held in the Fed’s headquarters.

“At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road.”

Bernanke sent a signal the Fed is gradually but steadily moving toward an exit from its supportive policies, even while evidence of the recovery has been mixed.

A report last week showing that U.S. employers shed more jobs than expected in September dented confidence in the recovery. But data released on Thursday showed gains in retail sales and a nine-month low in unemployment claims reinvigorated optimism.


The dollar inched up from 14-month lows against a basket of currencies after Bernanke’s comments, while his Fed colleague, Kansas City Fed President Thomas Hoenig, also warned of the perils of leaving rates too low for too long.

“I don’t believe necessarily an indefinite period of very accommodative policy is in the long-run best interests of the country,” he told an economic forum hosted by his bank in Oklahoma City.

“If you leave it at zero for too long a period, then we will have other issues,” said Hoenig, who is seen as one of the more hawkish, or anti-inflation members of the Fed’s policy-setting committee, where he will be a voter next year.

The dollar has been under pressure as the U.S. economy has lagged some other economies in recovering from a crisis that reverberated around the world.

On Tuesday, Australia became the first of the Group of 20 big industrialized and developing economies to increase borrowing costs, saying that the worst danger for the economy had passed.

Hoenig, asked by the audience about the Australian central bank’s decision, said this reflected the better performance of the country’s economy.

In the United States, most analysts do not see the Fed raising rates until the middle of next year.  Continued…

U.S. Watchdog Says Current Foreclosure Program is Not Enough

By Kevin Drawbaugh

WASHINGTON (Reuters) – Government programs to fight the U.S. home foreclosure crisis look increasingly inadequate and should be reworked, expanded and supplemented with new ideas, a congressional watchdog said in a report on Friday.

With a foreclosure filing occurring every 13 seconds, the United States is mired in a housing slump that is destroying billions of dollars in property values and threatening to choke off the economy’s recovery from a stubborn recession.

The foreclosure crisis has moved beyond subprime mortgages into the prime mortgage market, said the Congressional Oversight Panel for the Troubled Asset Relief Program, the $700 billion bailout launched under the Bush administration.

“Rising unemployment, generally flat or even falling home prices, and impending mortgage rate resets threaten to cast millions more out of their homes,” according to the report, which focused on the Treasury Department’s efforts to curb foreclosures.

“The panel urges Treasury to reconsider the scope, scalability and permanence of the programs designed to minimize the economic impact of foreclosures, and consider whether new programs or program enhancements could be adopted,” it said.

The report was sharply critical of the larger of the government’s two big programs designed to fight foreclosures.

It increasingly appears that the Home Affordable Modification Program, known as HAMP, which reduces monthly mortgage payments to help borrowers who are facing foreclosure keep their homes, is not equipped to deal with the changing nature of the housing crisis, the report said.

The government’s other effort to stem foreclosures, the Home Affordable Refinance Program, or HARP, helps homeowners who are current on their mortgages but owe more than their homes are worth, get more affordable loans.

As of September 1, the watchdog report said, HAMP had helped arrange 1,711 permanent mortgage modifications, with an additional 362,348 borrowers in a three-month trial stage. HARP has closed 95,729 mortgage refinancings, it said.

The five-member watchdog panel — sharply divided between Democrats and Republicans — is headed by Elizabeth Warren, a Harvard Law School professor and outspoken TARP critic……

Summer Stresses Support For U.S. Dollar

The chief economic adviser to President Barack Obama on Thursday reiterated the administration’s support for a strong dollar as concerns mount about the currency’s sharp decline.

Lawrence Summers, director of the National Economic Council, supported recent statements by Tim Geithner, the Treasury secretary whose office customarily voices the US stance on the dollar.

“I think he made very clear our awareness of the responsibilities we have in the US, and the special role of the dollar in the international system,” Mr Summers said of his colleague. The Treasury secretary had made clear “our commitment to a strong dollar based on strong fundamentals”, Mr Summers said.

Mr Summers was speaking at a foreign exchange conference in New York.

The dollar index, which tracks the currency’s value against six others, dropped to a 14-month low this week. The slide has caused some leaders to raise concerns about the dollar’s reserve-currency status.

Asian central banks on Thursday intervened in the currency markets to check the appreciation of their currencies against the dollar, fearing their countries’ exports could be losing ground as a result.

At home, Republican politicians have highlighted the dollar’s slide as evidence of waning US power.

Mr Summers, who served as the Clinton administration’s Treasury secretary from 1999 to 2001, said economic experience did not support the “idea that nations can devalue their way to prosperity”.

SEC Wants A Single Global Accounting Standard

The US remains committed to creating a single global accounting standard for public companies, Mary Schapiro, chairman of the Securities and Exchange Commission, said on Thursday.

She told the technical committee of the International Organisation of Securities Commissions in Basel, Switzerland, that regulators would announce a plan in the autumn for moving toward that goal.

“We must not lose sight of the fact that the purpose of accounting standards is to provide a clear and accurate picture of a company’s financial condition for investors … I remain committed to the goal of a global set of high-quality accounting standards,” Ms Schapiro said.

The US remains the most significant country not to have adopted the use of the international standards promulgated by the International Accounting Standards Board, preferring the GAAP standards set by the US-based Financial Accounting Standards Board.

US officials have long promised to work towards harmonisation.

Under Ms Schapiro’s predecessor, the SEC proposed a roadmap suggesting that US companies might be able to begin using International Financial Reporting Standards, known as IFRS, as soon as 2014.

But the global financial crash widened some of the gaps between US and international standards.

US standard setters in April softened fair value accounting rules for banks, which have allowed them to avoid taking paper losses on assets they intend to hold…..

How Is The Banking Sector Doing ?

According to the IMF the problems in the banking sector are far from over.  In their latest Global Financial Stability Report they find that the economy is improving, however, the risks to the banking sector remain.  They also conclude that any hiccup in the real economy would reverberate thru the banking sector and further intensify the weakness in the broader economy:

“The immediate outlook for the financial system has improved markedly since the April 2009
Global Financial Stability Report (GFSR) and extreme tail risks have abated. Financial markets have rebounded, emerging market risks have eased, banks have raised capital, and wholesale funding markets have reopened. Even so, credit channels are still impaired and the economic recovery is likely to be slow.

A key question addressed is whether the financial system can provide sufficient credit to
sustain an economic recovery. Recently, bank balance sheets have benefited from capital-raising efforts and positive earnings. Nonetheless, there are still serious concerns that credit deterioration will continue to put pressure on banks’ balance sheets. Our analysis suggests that U.S. banks are more than halfway through the loss cycle to 2010, whereas in Europe loss recognition is less advanced, reflecting differences in the economic cycle.”

The IMF estimates that banks have taken less than HALF of their total writedowns to date.  While commercial banks have already written down $1.3T the IMF estimates that banks have another $1.5T to writedown.  Of these writedowns, the U.S. is slightly further along than their Asian and UK counterparts.  This is similar to what McKinsey recently reported.


Much like Japan in the 90’s, the banks have been given the green light to earn their way out of this crisis.  With $1.5T in writedowns coming down the pipe it’s unlikely that operating earnings will suffice in offsetting the losses.  Banks are also facing a staggering $1.5T in maturing debt over the next 2 years.

“While stronger bank earnings are supporting capital levels, they are not expected to fully
offset writedowns over the next 18 months. Moreover, steady-state earnings are likely to be lower in the post-crisis environment. Stronger action to address impaired assets will help bolster bank earning capability and support lending. The tightening of bank regulation under way is expected to reduce net revenues and require more costly self-insurance through higher levels of capital and liquidity.”

The McKinsey report came to the same conclusion:

The challenge for many adequately capitalized banks is that they will find it difficult to generate enough income to cover loan-loss provisions over the next two years. Moreover, it is unclear how long net interest margins will hold up. Since 2006, net interest margins have actually increased for the stress-tested banks, despite rising nonaccruals (that is, when a loan defaults and a loan provision is made, it no longer accrues interest). For these banks, net interest margin has actually increased from 2.1 percent to 3.0 percent, which represents $70 billion of income annually. Much of this increase is due to rapid declines in funding costs thanks to the US Federal Reserve, which has lowered the rates banks pay faster than the interest on their loan and securities books. As more loans go on nonaccrual and as loans roll over, net interest margin may come under pressure, even if the Federal Reserve keeps rates low.

This likely means banks are going to continue to be a drag on any potential recovery as they struggle with their own capital problems as opposed to servicing the debt needs of their customers.


The IMF concludes that the economy is far from complete stability and any decline in economic activity could cause a ripple effect in the banking sector which could cause further deterioration in any recovery:

“the economic forecast for the remainder of 2009 and 2010 is still gloomy and banks are not immune to a deterioration in the economic environment.”

While we’re certainly seeing some positive trends in the banking sector and the broader economy it would be foolish to conclude that the secular deleveraging problems have been resolved.  Of course, the banking sector, being in bed with the government and the Fed, is unlikely to be allowed to wither.  Instead, it’s far more  likely that the banks will continue to benefit as the taxpayer loses, i.e., bailouts and taxpayer subsidized programs aren’t even close to being finished with.  What does this mean for investors? One heck of a mess for future generations.

Both notes are attached in their entirety below:


IMF Staff Position Note:


* All information on this website is provided for general purposes and should not be misconstrued as financial advice. Always consult your financial advisor before acting on any of the information herein. You should always assume that the author(s) could have a vested interest in topics described and may or may not own securities and instruments discussed.

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Editorial: Will China Create a Dollar Depression Through Diversification ?

Lesson From France Circa 1930

China’s “dollar trap” has many analysts worried about its future resolution. This column discusses a similar situation in the 1920s when France held more than half the world’s foreign reserves. France’s “sterling trap” ended disastrously. Sterling suffered a major currency crisis, French authorities lost a lot of money, and subsequent policy reactions deepened the Great Depression.

China’s huge volume of dollar reserves is now at the centre of serious concerns about the future of the US currency. The origin of this situation dates back to the early 2000s, after the East Asian and Russian crises. At that time, accumulating foreign reserves was considered benign policy. Developing and emerging countries were encouraged in this way in order to insure against sudden reversals of capital inflows. China was pegging its currency against the dollar and, due to the US trade deficits, started acquiring US assets.

Ten years on, the People’s Bank of China (PBOC) has an extraordinary stock of dollars, and one pressing question: “What to do out of them?” Increasing political tensions have given rise to fears that it might get rid of this huge bulk of securities and precipitate a dollar crash. In August 2007, a Chinese official indeed reminded that Beijing was in a position to provoke a “mass depreciation” of the dollar if it decided to do so. Recent suggestion by Zhou Xiaochuan that China’s central bank might shift from the dollar has put the issue on newspapers’ headlines once again.

But bold statements are one thing, and actual policy another. Up to now, China’s authorities have shown few signs of attempting to weaken the dollar. The reason for this seems straightforward. After all, China is the world’s largest dollar investor, and no one else would have less interest in seeing the value of the US currency plummet. The PBOC might be the promptest to support the dollar, not least because it would suffer a huge capital loss in the event of a dollar depreciation. In a recent New York Times column, Paul Krugman argues that China has “driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.”

This situation might appear unprecedented. But in truth, all this is not brand-new.

French foreign reserves policy during the Great Depression

Economic history offers one striking example of a country being trapped by the huge volume of its foreign reserves. This country was France, the period was the early 1930s, and the currency at stake the pound sterling. The episode ended up dramatically. Sterling suffered a major currency crisis, French authorities lost a lot of money, and their subsequent policy largely contributed to the Great Depression.

The origin of the problem lay in the government’s decision of 1926 to peg the franc to the sterling and dollar, two years before re-establishing the gold standard. Since the trade balance was in surplus and capital was flowing into the country, this goal was achieved through public purchases of foreign exchange. The Bank of France therefore accumulated a bulging portfolio of foreign holdings. At the end of the 1920s, the country held more than half of the world’s volume of foreign reserves.

French policy over subsequent years has been heavily criticized for being destabilizing. British contemporaries, like Paul Einzig, accused France of using its reserves in order to weaken the pound before the sterling crisis of September 1931. Others have noted that French conversions of foreign assets into gold after 1931, by imposing constraints on their money supplies, put intense deflationary pressures on other countries on the gold standard.

France’s Sterling Trap in 1931

Why did France engage in a policy that had such dramatic consequences? In a recent work, I explore the motivations behind the French reserves policy of this period. Spending time in the archives, I was able first to reconstitute the evolution of the reserves currency composition, and second, to identify the reasons invoked for the allocation decisions. Last, I have combined this information with market indicators of the perceived risk of reserves currencies.

France’s problems were similar to those of China today. The Bank of France was a private institution and its primary objective was to avoid capital losses. Its reserves were allocated between sterling and dollar. From 1929 to 1931, there were fears that the pound might be devalued and the Bank started shifting to the dollar (figures 1 and 2).

Figure 1. Bank of France’s Sterling Reserve (in millions of pounds sterling), 1928-1936

Figure 2. Bank of France’s Dollar Reserve (in millions of US dollars), 1928-1936

Source: Bank of France’s archives.

However, in implementing this policy, the Bank was also constrained by its position as a large player on the exchange market. So, as sterling’s weakness worsened at the end of 1930, the Bank was in a trap: it could not continue selling pounds without precipitating a sterling collapse and a huge exchange loss for itself. The only workable option left was to support the pound. French policy therefore suddenly turned cooperative. The Bank halted the sterling liquidations, and even intervened on the market in order to support the British currency.

When the pound eventually collapsed, the Bank of France was put into a state of technical bankruptcy. It was only able to survive thanks to a state’s rescue, obtained under tough conditions. Moreover, there were now rising fears over the dollar. The will to avoid further losses therefore led authorities to convert all their dollar assets into gold (figure 2), a policy that heavily contributed to the global monetary contraction of the 1930s.

Lessons for today?

What are the lessons for today? China’s objective function today certainly differs from those of France in the interwar years. But French experiences in the early 1930s are a reminder that when there is growing risk on reserves currencies, foreign reserves can be both a source of instability for the international monetary system, and a burden for large holders.


Accominotti, O., 2008, “The Sterling Trap: Foreign Reserves Management at the Bank of France, 1928-1936”, forthcoming European Review of Economic History.

Einzig, P., 1932, Behind the scenes of international finance, London: Macmillan.

Krugman, P., “China’s Dollar Trap”, New York Times, 2 April 2009

China threatens nuclear option-of-dollar-sales”, Daily Telegraph, 10 August 2007
This article may be reproduced with appropriate attribution. See Copyright (below).

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