The raging debate about the future of the U.S. dollar's reserve currency status may be masking the real drivers of its near-term direction.
Even as Russia, China and Brazil ratcheted up rhetoric about a new global reserve currency and diversifying their huge foreign currency stashes away from dollars, the U.S. currency has staged a remarkably healthy rebound this month.
Against the world's most traded currencies, the dollar has clawed back a quarter of the losses it has suffered since March -- losses that were driven by growing confidence in financial and economic recovery.
The billions parked in U.S. money market funds and Treasury securities during the worst of the credit crunch streamed out to seek higher returns in riskier plays such as equity, often outside the United States and significantly in emerging markets.
Fund tracker EPFR estimates that $104 billion has left money market funds since the start of the year and almost $30 billion flowed directly to emerging market equity, mostly since March.
But as the stock market rally has stalled, or at least taken a breather, the dollar has bounced more three percent.
And this bounce came in the face of persistent Russian and Chinese reserve warnings and ahead of Tuesday's summit between these two emerging giants and their new-found economic allies from the BRIC grouping -- Brazil and India.
SMOKE AND MIRRORS
So why has talk of diversification by the world's biggest reserve holders not weakened the dollar further?
After all, China and Russia hold more than a third of the $6.7 trillion global reserves stockpile and at least 50-60 percent of their combined holdings is denominated in dollars.
For sure, it was cited as a contributory factor as the dollar skidded through April and May. And data released on Monday showed public and private holdings of Treasuries held by Russian and Chinese names fell by $6 billion in April alone.
But analysts reckon this is small compared with the massive private sector investment swings in and out of the United States in recent months and probably for several months to come.
With equity and bond markets still torn by uncertainty about the next leg of the post-crisis economic story, the dollar's negative correlation with stock market nervousness appears to be re-establishing itself.
As stocks look to lurch lower again, the dollar may well attract another safety bid -- just as in the earlier part of the year.
Against that, central bank reserve shifts are unlikely to be either sudden or in great size.
For a start, major central banks from Moscow to Beijing or Brasilia would have as much as anyone to lose from any sudden or prolonged loss of confidence in the dollar, given they still hold hundreds of billions in dollar securities. Neither would they want to precipitate a financial crisis that could shock the consumers of one of their biggest export destinations.
Also, whenever the dollar weakens, central banks that fix their currencies at least partly to the dollar are forced to buy at least some dollars to maintain that peg. Periods of dollar weakness are therefore met with official dollar purchases -- even if the proportion is gradually less over time.
Analysts at Goldman Sachs point out that global reserve accumulation, which peaked about $7 trillion last summer, has resumed as the dollar has weakened since March and as crude oil prices surged.
Others point to the more recent debate about emerging countries switching U.S. Treasury holdings for bonds from the International Monetary Fund -- bonds that would be denominated in the IMF's basket currency, the Special Drawing Right.
However, this flow too may prove more marginal in the short run than it first seems.
Dollars already make up some 40 percent of the SDR basket, limiting the drop in dollar allocations from about 60 percent dollars at present.
As commitments to date from China, Brazil and Russia to the proposed IMF bonds amount to about $70 billion, that would involve a reduction in dollar holdings of $14 billion at most.
The IMF itself is adamant there is no risk the dollar's dominant status for some time.
The dollar is the principal reserve currency in the global economy and will remain so for as far as we can see, IMF First Deputy Managing Director John Lipsky said on Monday.
So is this is a story for another day?
The prospects of an aggressive change in the U.S. dollar allocation in the Russian foreign reserves remains very low, Commerzbank analysts told clients on Monday.
But it is also worth stressing here that the secular move away from the U.S. dollar into other regional bellwether currencies in the emerging markets space is still on, and will probably intensify over the next many years.
Goldman Sachs takes a similar view: We do believe that the dollar will effectively remain unchallenged as the main reserve currency for a long time but there is also little doubt that the constant reserve diversification talk creates uncertainty.
(Editing by Ruth Pitchford)