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China, Japan to Buy More Dollars
Feb. 11

Feb. 11 (Bloomberg) -- The Chinese and Japanese central banks will probably increase their holdings of dollars as they seek to counter advances in their currencies, said David Hale, chairman of Hale Advisors LLC.

"China will not allow its currency to appreciate in 2005, nor will Japan," Hale, whose clients include hedge funds and other investment management firms, said yesterday in a speech at a mining conference in Cape Town, South Africa.

Purchases by investors in Asia, where the central banks of Japan and China buy dollars to limit the appreciation of their currencies, are helping support the dollar, according to Federal Reserve officials including Chairman Alan Greenspan.

Hale, a member of the Academic Advisory Board of the Fed's Chicago branch and an adviser to the Hong Kong Monetary Authority, joins Morgan Stanley in predicting Japan and China will boost their dollar holdings. Japan sold record amounts of yen in the first quarter of last year to limit its appreciation.

Japan will probably boost its foreign reserves to $1.5 trillion in the next two to three years from January's $821.2 billion, said Hale, who is writing a book on China's economy.

China, which has pegged the yuan at about 8.3 per dollar since 1995, will increase its reserves to $1 trillion within three years from $609.9 billion, said Hale, who is based in Chicago and is a former chief economist at Zurich Financial Services.

Chinese and Japanese investors, including the nations' central banks, are the two biggest holders of marketable U.S. Treasury securities, accounting for more than a fifth of the total outstanding as of November, according to the Treasury Department. Japan held $714.9 billion and China had $191.1 billion of the $3.95 trillion, the figures show.S

`Bad for Confidence'

Fewer purchases of Treasuries by Asian central banks would send U.S. 10-year yields up as much as half a percentage point, according to Ralph Axel, a bond strategist in New York at HSBC Securities USA Inc.

"As soon as the market catches a whiff of reduced demand from central banks, that would be bad for confidence," sending U.S. yields higher, Axel said in an interview on Feb. 9.

HSBC is one of the 22 primary dealers in U.S. government debt that trade with the Fed's New York branch. Axel forecasts the 10 year yield will climb to 4.5 percent by mid-year from 4.08 percent at 1 p.m. in Tokyo.

International investors bought a net $81 billion in Treasury notes, corporate bonds, stocks and other U.S. financial assets in November, up from $48.3 billion in October, the Treasury Department said on Jan. 18. Figures for December are scheduled for release on Feb. 15. Foreigners held a record $1.9 trillion in Treasuries at the end of November.

Euro Reserves

The dollar fell as much as half a percent against the euro on Jan. 24, after a survey sponsored by Royal Bank of Scotland Plc showed central banks boosted their euro holdings at the expense of the U.S. currency.

Almost 70 percent of the 56 central banks surveyed said they increased exposure to the 12-nation currency, according to the survey conducted by Central Banking Publications Ltd., a London- based publisher, between September and December 2004. Fifty-two percent said they reduced exposure to the dollar.

HSBC Holdings Plc, Europe's largest bank by market value, and Merrill Lynch & Co., the world's biggest securities firm by capital, expect Asian central banks to increase their assets held in currencies other than the dollar.

"I think it unlikely" that central banks such as China's will keep most of their reserves in Treasuries, HSBC Chief Executive Officer Stephen Green said in a speech to a conference in Mumbai on Feb. 9.

U.S. Treasuries were the second-worst performing major government market in the world last year, returning 3.5 percent to investors, according to Merrill indexes. Only Japanese bonds, which returned 1.3 percent, did worse among the world's largest sovereign-debt markets, the data show.

Merrill's Call

Merrill, the most accurate forecaster of exchange rates in the year to Sept. 30 according to a Bloomberg survey, said on Feb. 3 that central banks may invest in stocks and bonds and increase their holdings of currencies other than the dollar, as they seek to raise returns on their foreign-exchange reserves.

"The current holdings of dollars by central banks over- represent what a benchmark would look like," Alex Patelis, the firm's chief G-10 currency strategist, said in an interview on Feb. 3. "If you're looking for attractive long-term returns, longer-dated bonds, equities and riskier investments are the type of assets to buy." Most reserves will stay in dollars, he said.

Merrill estimates the U.S. currency will trade at $1.36 per euro and 91 yen in 12 months. The dollar traded at $1.2876 against the euro and at 105.82 yen in Asia.

`Very Little Appetite'

Morgan Stanley, the world's second-largest securities firm by capital, predicts demand for the dollar will be supported by central-bank purchases this year, said Stephen Jen, the company's global head of currency research in London.

"There is very little appetite for diversifying out of dollars from either Japan or China at the moment," Jen said on Feb. 4. He forecasts the dollar at $1.24 per euro and 96 yen at year-end, from $1.3552 and 102.63 yen at the end of 2004.

Asian purchases of U.S. assets "may be supporting the dollar and U.S. Treasury bond prices somewhat," Greenspan said in a Feb. 4 speech in London. Fed Governor Edward Gramlich told a business group in Pittsford, New York on Feb. 7 that Japan and China are "building up huge hoards" of Treasuries, which is "keeping the dollar strong."

The Bank of Japan, acting for the Ministry of Finance, sold 14.8 trillion yen ($140 billion) in the first three months of 2004, following record sales of 20.4 trillion yen in 2003. The sales helped limit the yen's 2004 gain to 4.5 percent, compared with the euro's 7.6 percent advance.

The share of dollars in total reserve holdings was 63.8 percent at the end of 2003, down from 63.5 percent in 2002 and 66.9 percent in 2001, the International Monetary Fund said in its annual report in April. The euro proportion rose to 19.7 percent from 19.3 percent in 2002 and 16.7 percent in 2001.

To contact the reporters on this story:
Chris Anstey in London at  canstey@bloomberg.net; Antony Sguazzin in Johannesburg at (27)   asguazzin@bloomberg.net

To contact the editor responsible for this story:
Daniel Moss at  dmoss@bloomberg.net.

Last Updated: February 10, 2005 23:13 EST