Asian Central Banks Play Chicken With the Dollar
March 11 (Bloomberg) -- Asian central banks are poised on the edge a cliff. Who will be the first to jump?
Late last month, traders pummeled the dollar when they learned South Korea's central bank was looking to boost returns on its foreign-exchange reserves with non-U.S. government bonds.
Within hours of the revelation, courtesy of an annual report to the legislature that was hyped by the media, the Bank of Korea was forced to issue a press release saying it had no plan to sell dollars.
Fast forward two weeks, and China's central bank governor made noises about dropping the yuan's peg to the dollar in favor of a basket of currencies. China's finance ministry countered with an opaque statement -- something about keeping the currency stable.
The same day, the Japanese government found itself in a similar predicament of having to appease foreign-exchange markets by contradicting itself. Prime Minister Junichiro Koizumi told the budget committee of the upper house of parliament that Japan needed to diversify its foreign-exchange reserves, which at $840.6 billion are the world's largest and are held mostly in U.S. dollars.
This time, it took less than an hour for a no-name Ministry of Finance official to issue a we-didn't-mean-it statement. The Prime Minister was speaking generically, the nameless official said.
All across Asia, central banks that peg or manage their currencies to the dollar are facing the same predicament: whether to shoot themselves in the foot by reducing their dollar holdings, thereby depressing the value of the dollar even further; or to dig themselves into a deeper hole, buying more dollars to prevent their currencies from appreciating and plowing the money into U.S. Treasuries.
Currently foreigners own 53 percent of privately held marketable U.S. Treasuries, which excludes the Federal Reserve's holdings. More than half of that is held by foreign central banks.
The choices the banks face aren't great. The dollar dilemma is an even a bigger deal in Asia than the low-long-rate conundrum is in the U.S. Financial market professionals I've met traveling through the region, including folks who manage the foreign- exchange reserves at various central banks (no, they don't reveal any trade secrets), all agree the dollar has problems.
They're less clear on the solution. The perceived arrogance of the U.S. -- the idea that the dollar is our currency but someone else's problem -- doesn't sit well overseas.
I explain that it's less arrogance than a lack of viable solutions. There's no constituency in the U.S. for sharply higher real interest rates, which is what it would take to induce consumers to change their profligate ways (save more). And the party of limited government has learned that bigger (government) is actually better when it comes to courting the folks back home.
Still, there's a sense that the U.S. needs to clean up its act, put its house in order, address the large twin deficits (budget and current account). Just call it 1980s redux.
When I point out that Germany, Europe's largest economy, has exceeded the mandated deficit-to-GDP ratio of 3 percent for three years running -- and isn't the only repeat offender -- I get blank stares. The U.S. is still bigger and badder.
If these rumblings from Asian central banks on diversifying their foreign-exchange reserves and rebalancing their portfolios are indeed shots across the bow, they might want to rethink their strategy in favor of less talk, more action.
Central bankers need to understand the concept of first-mover advantage. While the term generally applies to the advantage that accrues to the first company to move into a specific market -- big rewards in return for sizeable risks -- it's applicable to central banks as well.
It would be much smarter for these banks to quietly sell dollars, if that's what they want to do, without calling attention to it. They could take lessons from the private sector, from big money managers like Bill Gross of Pacific Investment Management Co., for example, who's a master of the ex-post outlook.
They also might want to get their priorities straight. Asian central banks can't sell dollars and expect their currencies to weaken against the dollar. They can't diversify their foreign- exchange reserves away from dollars and, at the same time, prevent their currencies from rising and diluting their export advantage. It just doesn't add up.
Beg To Differ
Implicit in their game of chicken with the dollar is the notion that the U.S. should do something so the burden doesn't fall on the rest of the world. Once you realize that Asian exports to the U.S. were 19 percent of Asia's gross domestic product last year, you start to understand that slowing U.S. growth may do more harm than good. A strong U.S. economy, it seems, is in Asia's best interest.
Fed Chairman Alan Greenspan has become more sanguine about the current-account deficit recently, even as he's raised the level of concern about the budget deficit. In a speech to the Council of Foreign Relations in New York last night, Greenspan said the resolution of the current-account deficit, which is approaching 6 percent of GDP, and the household debt burden, which remains at near an historic high of 13.26 percent, were not ``overly worrisome.''
This is one area where Greenspan's counterparts in Asia just don't agree.