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Desire to Curb Asian Currencies Leads to Surplus of U.S. Dollars
By JASON BOOTH
Staff Reporter of THE WALL STREET JOURNAL
The strengthening won is fueling expectations that South Korea's central bank will intervene in the foreign-exchange market to halt the won's rise. But if the Bank of Korea does buy the U.S. currency, it will have a different problem: where to put all those extra dollars.
South Korea isn't alone. Like many of its Asian neighbors, it is already awash with about as much of the U.S. currency as it knows what to do with.
Despite having just come through the worst trade slowdown in more than a decade, Asia has seen its foreign-exchange reserves swell to an all-time high of $1.2 trillion, up $100 billion since a year ago.
To put that in perspective, there are currently only $1.7 trillion worth of reserves held by central banks world-wide. The six economies with the largest reserves are all Asian. Even Thailand's total reserves of $35 billion are greater than those of the U.S. itself.
Renewed investor confidence in Asia has resulted in tens of billions of dollars pouring into the region over the past six months. That trend might accelerate as U.S. corporate train wrecks such as Enron Corp. and Global Crossing Ltd. make investors wary of U.S. assets, including dollars.
"I think the depreciation of the dollar will continue, because of the growing distrust toward the U.S. financial system," said Jeong Young Sik, a senior researcher at Samsung Economic Research Institute. And in parts of Asia, most notably Korea, that liquidity now appears to be seeping out of central-bank coffers and into the wider economy, helping to push up equity and property prices.
Having so much money in the bank sounds impressive, but it is also a sign that Asian governments have been unwilling to allow their currencies to float freely -- something most say they want to do after the disasters of 1997, when fixed currencies suddenly came unglued and set off panic among investors and local residents alike.
As Asia has recovered, many central banks across the region have been aggressive buyers of the dollar, both directly, or indirectly through state-controlled banks. The aim is to depress their own currencies, thus keeping their exporters competitive in the global marketplace.
"Who says that Asia has embraced the concept of floating exchange rates," said Desmond Supple, head of Asian research at Barclays Capital in Singapore. His broad concern is that artificially depressed currencies are acting as a "subsidy" for exporters, allowing them to avoid the painful restructuring needed to improve their productivity.
Hefty foreign reserves have long been a symbol of economic strength in Asia. Japan's world-leading $407 billion worth of reserves is one reason the government can claim that it will never default on its foreign debt obligations, despite a recent downgrade of its credit rating. In China, reserves of $231 billion (expected to approach $300 billion next year) are insurance against a creaking banking sector, which some analysts say will require a major financial bailout in coming years, possibly totaling half a trillion dollars.
Taiwan needs its $133 billion in case it goes to war against China. Thailand and the rest of Southeast Asia hope their reserves will ward off a speculative attack on their currencies, like the one that sparked the 1997 financial crisis.
But now there are signs that these reserves are reaching a scale where some central banks either can't or don't want to absorb so much capital. That trend is already leading to rising money-supply figures in much of Asia, as every dollar the central banks don't mop up is left sloshing around in the broader economy.
Rising liquidity typically means rising inflation. These days, however, that is good news for most of Asia and investors in the region, given that economies including Japan, China and Hong Kong are locked in a deflationary cycle of falling prices.
The fading will to weaken Asian currencies is most apparent in South Korea, which has foreign reserves of $108 billion. To neutralize the inflow of dollars into the economy, the Bank of Korea typically buys the U.S. currency from other banks. The central bank then issues won-denominated "monetary-stabilization" bonds to the banks, in order to suck up the won currency that it has just spent in order to buy the dollars.
These days, however, the central bank appears ready to let the extra liquidity remain in the market, in part because the issuance of so many bonds had been driving up interest rates. Issuance of monetary-stabilization bonds grew just 9.8% from a year earlier in March, according to the Bank of Korea, the slowest rate since January 1998. The growth rate was 13% in the first three months of the year, down from 22% during the same period of 2001 and 29% in the first quarter of 2000.
Effect on Money Supply
The impact on the money supply is already evident in various Asian nations, such as Taiwan and Malaysia.The trend is most clear in South Korea, where M2 money supply rose 9.9% in the first three months of the year, compared with 5.3% in the same period of 2001. While that has helped spur the stock market and fueled a booming property market, it also has raised the specter of inflation.
As such, some economists say that despite recent protests to the contrary, the South Korean government won't be too concerned about the strengthening won, which will lower the price of imports and help damp inflation.
"The government was pressured by inflationary pressure caused by strong domestic demand, but the strong won might have a cooling-down effect," said Jwa Sung Hee, president at Korea Economic Research Institute in Seoul.
-- Meeyoung Song contributed to this article.
Write to Jason Booth at jason.booth@wsj.com
Updated June 3, 2002
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