Developments in the Currency Markets

Some interesting developments in the foreign exchange markets in the last couple of days, according to the Financial Times:

The US dollar was sharply lower on Tuesday after South Korea re-ignited fears that central banks plan to diversify their foreign exchange reserves away from the greenback to include more currencies.

The Bank of Korea said on Monday that “as foreign exchange reserves increase”, the Bank would “diversify the currencies in which it invests”, as well as targeting higher yielding investments. Seoul has $200bn of foreign exchange reserves, the fourth highest figure in Asia… With the vast majority of these reserves held in dollar-denominated assets, the dollar is vulnerable to any moves by Asia to spread risk by reducing the proportion of reserves held in dollar assets.

Some countries, such as Russia, have already embarked on such a process, and amid concerns among currency traders that China and other Asian banks might follow suit, the Korean comments led to a general wave of dollar selling.

George Soros, the US investor, kept the pressure on the dollar by claiming that oil exporters, including Russia, were continuing to switch out of dollars, moving mainly into euros. OPEC nations have reduced the proportion of their reserves held in dollars during the past three years. And the Indian government could next week back a plan to use a portion of its $130bn of foreign exchange reserves to fund domestic infrastructure projects.

Most likely these are just a series of minor developments that will have no serious repercussions by themselves. But another possibility is that they are some of the first pebbles that start the avalanche…