Russia sees 'window of opportunity' to cut its holdings of US debt

Russia will reduce the proportion of U.S. Treasuries in its foreign exchange reserve, and buy International Monetary Fund bonds, in a diversification move, First Deputy Chairman Alexei Ulyukayev announced Wednesday, Reuters reported.

The dollar slipped slightly Wednesday against the world's other major currencies on word of the Russian action. The dollar traded down about one-half cent against both the euro and the British pound, to $1.4027 and $1.6356, respectively. U.S. Treasuries also fell on the news, with the 10-year bond rising five basis points to 3.92 percent.
Russia has the third largest total of U.S. Treasuries in the world. Of the nation's $404.2 billion in hard reserves, which include hard currencies, about 30 percent are in U.S. Treasuries.

"Now this share (of treasuries) will fall because the window of opportunity is opening, the situation with banks is becoming clearer. We will increase the share of bank deposits, the share of repos will be bigger as well," Ulyukayev said, Reuters reported Wednesday.

Earlier, Russia had pledged to buy about $10 billion in IMF-issued bonds, as part of an effort to fund an IMF account designated to help nations hurt by the global financial crisis. China is also expected to buy up to $50 billion of the IMF bonds, IMF Managing Director Dominique Strauss-Kahn told Bloomberg News Wednesday.

Russian President Dmitry Medvedev, among other world leaders, have questioned the U.S. dollar's future as a global reserve currency, arguing that a basket of regional currencies would make the global economy more stable, Bloomberg News reported Wednesday.

Impact on U.S. interest rates

Due to the bank bailout and a fiscal stimulus package designed to help jump-start the U.S. economy, the U.S. government is on pace to post a record $1.8 trillion budget deficit this year, fiscal year 2009 -- or more than four times last year's all-time high. What's more, this year's deficit occurs after a decade during which the national debt roughly doubled to more than $10 trillion at the end of 2008 from about $5.7 trillion at the start of 2001.

The large deficit and national debt has led to concerns that U.S. interest rates will rise, as the U.S. government is forced to raise rates to attract capital from competing -- and potentially higher-returning -- foreign investments. Up until mid-spring, interest rates had remained relatively low, as the U.S. benefited from a "flight to safety" and "risk aversion" amid the financial crisis and global recession.

However, recent signs that the global recession may be bottoming, and that the dollar may weaken versus other currencies, due to the large amount of dollars in supply, or that U.S. inflation may increase, has led some nations, such as Russia and China, to re-evaluate their currency holdings. Further, although Russia characterized their upcoming U.S. bond sale as part of a move to fund the IMF, many economists see Russia's action as part of that currency diversification strategy. In either event, Russia's action, like other potential sales of U.S. Treasuries, is negative for the dollar. It also will increase U.S. interest rates, if other nations follow suit.

"This is potentially quite negative for the dollar," said Geoff Kendrick, senior currency strategist at UBS in London, told Reuters Wednesday. "The main jump was in sterling . . . If anyone just now would benefit it would probably be investments into sterling [British pound] as a reserve currency."

Russia's economy rose to top-tier emerging market status after recording a decade of GDP growth that averaged 7 percent, including capital growth and personal income growth that averaged more than 10 percent, according to research compiled by the U.S. Central Intelligence Agency. In 2008, Russia posted GDP growth of 6 percent, but the global recession that collapsed oil prices and reduced international trade threw the nation's $2.2 trillion economy into a recession. Infrastructure spending, efforts to diversify the economy, and the rise in oil's price from $35 to above $65 per barrel, have strengthened domestic fundamentals such that a recovery is likely in late 2009/early 2010.

Economic Analysis: As noted earlier, the United States' window of "easy international credit terms" and "low monthly payments" for the national debt is ending. Risk aversion piled international investors into U.S. Treasuries, keeping interest rates low, given the large U.S. budget deficit. Russia's action, if replicated by other major economies, and the recovery in the global economy, would lead to a flow of capital out of dollar-denominated investments and into other investments and currencies, driving up U.S. interest rates.

The solution? As soon as possible, U.S. policy makers must take actions to cut the federal budget deficit, which will decrease the U.S. Treasury Department's borrowing requirement. And that means: 1) raising income taxes on upper income groups and 2) eliminating unnecessary federal government spending.

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