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Central bank diversification

Reports have surfaced that India’s central bank has joined the list of Asian central banks that are considering diversifying their reserve assets. Because Asian central banks have such huge holdings of dollars, any talk of diversification bodes poorly for the dollar, which sits on a precipice on the world’s foreign exchange market.

The dollar just hit a record low against the euro, which is becoming the dollar’s primary competitor in world commerce. Another indication of the dollar’s dire straits: it is at a 26-year low against the British pound sterling, which now costs more that $2 to buy.

But, most watched is the US dollar Index (USDX), which is a basket of major currencies. The USDX hovers just above 80. A fall through 80, according to most currency analysts, could be disastrous, although 79 may be the critical level because while the dollar has traded below 80, it has never traded below 79.

Considering the precarious plight of the dollar, Asian central bank selling would a nightmare for the U.S. Treasury. While wholesale dollar dumping would most certainly result in the dollar dropping through 79, even some diversification could send the dollar spiraling downward.

However, one has to keep in mind that that the people running central banks, while they do some stupid things-like the UK’s selling gold five years ago at the bottom-they are not idiots. They know that wholesale dumping of dollars is out of the question, but slow, steady additions of gold to their holdings would be manageable.

Will they do it? That’s a good question, but Asian central banks diversification is a real possibility. They know they are holding too many dollars, which are nothing more than computer entries that can be created at will.

While adding gold reserves makes sense for Asian central banks, they cannot bring their gold holdings to levels held by European central banks. There is not enough gold for that to happen.

In the European Union, member states hold huge percentages of their assets in gold. Portugal tops the list with 77.4% of its reserves in gold, and economic powerhouse Germany holds 63.2% in gold. Italy has 66.0% in gold, and Spain, a recent gold seller, 40.7%. Even the UK, which made its infamous gold sales at the bottom of the market five years ago, still has 13.1% of its reserves in gold.

In contrast, Asia central bank reserves are mostly dollars, with gold making up only tiny portions. China, with total reserves close to $1.2 trillion, holds only 1.1% of its reserves in gold. Japan, with some $925 billion in total reserves, holds only 1.8% in gold. Similar ratios are found in at other Asian central banks, including Russia. India, about which rumors are now circulating, holds about $236 billion in reserves with only 3.8% in gold.

Considering the huge portions of EU central bank reserves in gold, Asian central bankers must turn green with envy, they being stuck with computer credit dollars while their counterparts hoard hard, physical gold bars.

But, the hard reality is that Asian central banks cannot bring their gold holdings in line with EU central bank holdings. Still, Asia central banks may-and probably will-add gold in moderate amounts, and even moderate gold purchases by Asian central banks could send the dollar south and gold climbing to new highs.  Maybe it is time to consider investing in gold.