Ignore Noise About Dollar's Demise

This column was originally published on RealMoney on Dec. 29 at 1:00 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

In my last column, I examined several investment themes that could come into play in 2007. In the spirit of having to re-learn this coming year (as I do almost every year) that our best trade is frequently the one we did not make, the wreck we avoided, I'd like to suggest a theme that might get a lot of airplay but is probably really a distraction.

The reserve diversification issue may be for the foreign-exchange market what the Y2K issue was for the general public. The topic has generated a lot of heat but very little light.

Unimpressive Numbers

Earlier this month, the Financial Times ran a front-page story about how oil producers were "shunning the dollar." This "shunning" was a reference to data from the Bank for International Settlements' quarterly report, which noted a roughly $5.3 billion decline in dollar-denominated deposits among Middle East oil producers in the second quarter of 2006. But a subtle detail was lost on many observers: the fact that yen-denominated deposits rose slightly more than euro-denominated deposits.

This week, the United Arab Emirates' confirmation that it plans to shift $2 billion of its dollar-denominated reserves to euros in the coming quarters also captured the imagination of pundits and observers. This followed hard on the heels of word that Iran is not only shifting its reserves into euros but has begun invoicing its oil sales in euros rather than dollars -- more evidence, we're told, of the dollar's demise.

This makes a good talking point only if one plays down the modest size of the numbers involved and ignores other important data. The $5.3 billion decline in dollar-denominated deposits in the Middle East still means that 65% of the deposits are in dollars.

The takeaway from the UAE's decision is the same; after implementing its diversification program, the UAE still will have 90% of its reserves in dollars. Its diversification program entails the sale of about $2 billion over the next several quarters, which can be easily absorbed by the foreign-exchange market, where the turnover is estimated at $2.5 trillion a day or more.