Ignore Noise About Dollar's Demise

Among the most fickle investors in U.S. Treasuries are not foreign investors but the American investors who take advantage of the tax-free havens in the Caribbean. The Caribbean community sold about $9 billion of U.S. Treasuries in the January-October 2006 period, more than offsetting the $2 billion bought during the entire calendar year 2005.

More recent data than the October TIC report suggest there's less to the reserve diversification story than meets in the eye in the press or on television. The Federal Reserve offers some basic custodial services to foreign central banks. It reports its holdings for them every Thursday. In December, the Fed's custody holdings for foreign official accounts swelled by about $34 billion, on top of a gain of $18 billion in November. The December rise is a little bigger than the increase recorded during the August-November period.

Stay Independent

What does all this mean for the dollar's outlook? It means that one needs to arrive at a view independent of what the central banks may or may not be doing. And it suggests that in periods when overall reserves are growing and financial assets are growing, diversification can take place without dollars having to be sold on a net basis.

The nearly 14% rise of sterling against the dollar this year and the just more than 11% rise of the euro probably contributed more to the diversification of reserves and foreign-exchange deposits than outright dollar sales.