May 25, 2007 – Recently it was reported that the finance ministers from Japan, South Korea, Thailand, and China among other Asian countries would meet in Kyoto to discuss pooling some of the region’s $2.7 trillion in foreign-denominated reserves to serve as a buffer against speculators driving down the value of their domestic currencies as happened during the 1997 financial crisis. Though this is the “official” reason being offered to the financial media, and one that has not been challenged by the financial press, I’m not buying it. To begin with the financial crisis happened more than 11 years ago and protection against speculators moving currency markets in Asia was already addressed by the 2002 Chiang Mai initiative.
Has Japan’s and Thailand’s stock market risen so much in recent years that they are concerned about speculative outflows of capital triggering precipitous declines in their respective currencies? Hardly. Or perhaps they are concerned about a strong correction in the Shanghai index triggering outflows of capital from the region. This would be a more realistic concern, but still highly unlikely that an expected Chinese correction would trigger massive drops in other regional markets. The real unspoken reason is quite simple, and exactly opposite of what the media has been writing. These countries are worried about a possible rapid descent in the dollar causing great appreciation in their domestic currencies. In turn, this rapid appreciation of their domestic currencies would cause their economies’ growth to come to a grinding halt as export business would rapidly disappear. This concern is especially relevant in those countries that have already had abnormal appreciation of their domestic currencies (even with the dollar’s decline) where central banks have catered exclusively to the interests of special interest groups instead of the welfare of the entire country.
The involved countries claim that such a pool is important because it will help buffer domestic currencies against speculative attacks and prevent the need for countries to once again depend on loans with punitive conditions from the International Monetary Fund (IMF) as Indonesia, Thailand and South Korea was forced to do during the 1997 financial crisis. While certainly this is a valid concern and one that needed to be addressed, if the 2002 Chiang Mai accord didn’t adequately address this concern, why was it not addressed in 2003, 2004, 2005 or 2006? Certainly these same countries wouldn’t let such great vulnerabilities continue to endanger their economies if they felt the 2002 Chiang Mai accord didn’t adequately address them. Of course they mention that the Chiang Mai accord only offered bilateral solutions whereas the new reserve pool will offer multilateral solutions. Well, these countries could have met to offer multilateral solutions for the past five years if they were really concerned about speculative attacks against their currencies.
Despite the recent strength of the dollar against the yen I think what has happened now is that this group of Asian countries has concluded that the U.S. dollar will continue to weaken and they are trying to reach an accord as to how to diversify their pool of reserves to meet their different goals. Since the 1997 crisis, total Asian foreign currency reserves have increased from a miniscule $485 billion to an enormous $3.37 trillion, the bulk in U.S. dollars. That’s a lot of reserves to hold in a currency that has lost more than 20% of its value in some Asian countries just within the past couple of years.
China, the majority holder of these dollar denominated reserves, with more than $1 trillion, has been aggressively seeking to convert their reserves into acquisitions of real assets, first by establishing their own oil reserves and most recently by spending $3 billion to buy a stake in the U.S. private equity firm Blackstone. Although it may seem logical to think that the purchase of other assets with U.S. dollars by foreign countries merely shifts ownership of dollars from one country to another, keeps supply level the same and should not weaken the dollar that much, these actions will weaken the dollar considerably as efforts to spend dollars will certainly be viewed as a weakening of demand for the dollar. If countries were spending Euros, perhaps the perception wouldn’t be the same given the relative recent strength of the Euro. For the U.S. dollar, perception will be much different as certainly huge purchases of real assets with U.S. dollars will be perceived as a desire to get rid of a weak currency and cause further downward pressure.
While the decline of the dollar is more of an immediate concern for foreigners where the purchasing parity power is greatly reduced by holding the dollar, even for Americans, there must be concern with getting paid in a currency that has increasingly weaker purchasing power globally. Just ask an American that has visited London recently how worthless the dollar is now. The fact is that about half of all revenues of companies listed on the S&P 500 come from overseas. If these companies have to spend dollars to expand overseas operations and therefore increase overseas profits, and these dollars continue to buy less, eventually they will not want to see dollars come back to them, even massive amounts like the $3 billion China just spent to acquire a piece of Blackstone.
Coming soon…Part II
[tags]dollar crisis, Chiangmai accord, Asia pooling currency reserves, 1997 financial crisis[/tags]
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J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.
