Asian Investors Risk Losses on Dollar Holdings After S&P Outlook Cut
Managing Digital Editor, CNBC International
S&P's threat to downgrade the U.S.'s AAA credit rating is a wake up call for Asian investors, according to one senior economist.
John Silvia, Chief Economist at Wells Fargo told CNBC on Tuesday that the current U.S. budget situation was unsustainable over time.
"If significant progress is not made you will probably get a depreciating dollar, probably higher interest rates, higher inflation, which means that many Asian investors will have capital losses on their U.S. treasury portfolios," Silvia added.
Asian central banks are big holders of U.S. government debt. China is the world's largest owner of Treasurys with $1.154 trillion worth of the paper according to data from February. Japan is the second-largest holder of the debt with $890 billion. But even other, smaller central banks have large holdings. According to Treasury data online, Taiwan has $156 billion and Hong Kong $124 billion.
Several analysts agreed that the S&P report would speed up the decline of the dollar.
Rudy Martin, emerging markets analyst at Weiss Research said the ratings downgrade had effectively already happened over the weekend when at a meeting of BRIC nations, the bloc said they would work towards the establishment of a new reserve currency.
"The U.S. controlled the casino and used their own currency and effectively over the weekend Brazil, Russia, India, China and South Africa got together and said we're going to set up our own casino, using our own currencies for trade and using our own currencies for reserve measures," Martin told CNBC.
But China is unlikely to reduce its holdings of dollars in the near-term according to Martin and other analysts.
"You've heard this from PIMCO and you've heard this from a variety of long-term investment managers, it takes time to move large amounts of capital from one positioning structure to another," Martin said.
The S&P report led to a drop in stocks overnight, with the Dow dropping 1.1 percent, but ironically Treasurys rallied and yields dropped as investors sought safe-havens.
Speaking before S&P slapped the negative outlook on the U.S., Chi Lo the CEO of HFT Investment Management in Hong Kong said, "If (China) cuts its U.S. Treasury holdings significantly, other central banks and investors might follow, prompting a crash in the USD exchange rate... Due to this potential damage, it is unlikely that China would cut its Treasury holdings quickly and sharply."
In the near-term, though, the slow decline of the dollar is likely to continue to boost alternative assets such as commodities.
Marc Faber who has been a critic of the large fiscal deficits in the U.S. and the Fed's easy money policy told CNBC on Monday that investors need to diversify out of the dollar. He recommended investors accumulate gold and silver and "be their own central banks."