This was taken off the IHT site.

Commentary: Asians are calling the shots on currencies
By William Pesek Jr. (Bloomberg News)
Monday, January 5, 2004

TOKYO: What a difference a couple of years make in the currency markets. The once mighty dollar is now sliding, while the once feeble euro is surging. The question is, when will the euro supplant the dollar as the No.1 global currency?

Answer: When Asia says so.

Central banks in this region hold vast amounts of dollar assets, meaning they will decide the dollar’s fate. And Asian monetary authorities are still overwhelmingly invested in dollars.

There are two reasons for this. One is lingering skepticism about the stability of the euro in the age of global terrorism and the economic outlook. The euro’s two pillar economies, Germany and France, recently set a terrible precedent for smaller members by tossing aside budget deficit limits. Imagine what lesser economies may try to get away with.

Second, holding dollar assets allows Asian central banks to avoid the thing that scares governments: a falling dollar. Asian governments worry that a continued drop in the currency of the world’s biggest economy will choke off the region’s post-1997 recovery. So, for better or worse, the dollar remains king and will remain as such until Asians turn to the euro.

This is a good news-bad news scenario for Europe. Good news because its single currency is finally winning the trust of investors; bad because the euro’s 20 percent rise versus the dollar last year is making economies less competitive and crimping growth.

European economies and companies have been bearing the brunt of Japan’s huge yen sales. By devaluing the yen, Tokyo indirectly bolsters the euro, too.

The fact that the fate of euro bulls and dollar bears largely rests with folks in Asia means investors are paying closer attention to currency flows. Analysts who once spent their Thursdays poring over the Federal Reserve’s money supply figures now dissect the Fed’s “custody holdings” data with similar enthusiasm.

The data show which currencies the monetary authorities are buying and selling. In mid-November, foreign central bank holdings of U.S. Treasuries exceeded $1 trillion for the first time and are still rising, largely because of Asian purchases. Between January and August alone, Asian holdings of U.S. debt jumped by more than $100 billion.

Yet even continued dollar-asset purchases by Asians can’t save the U.S. currency if investors turn against it. The dollar’s decline last year reflected investor concern about U.S. imbalances, namely record current-account and budget deficits.

For Asia, a full-blown dollar crisis would be disastrous. It would send shockwaves around the globe and prompt investors to move into less risky assets. It is not clear that Asia offers the kinds of “safe-haven” investments to which capital would flock. Also, it would slam the purchasing power of U.S. consumers, whose buying patterns are now the source of Asian optimism.

An orderly drop in the dollar also could have big implications for Asia. In the short run, it could hurt the region’s export-dependent economies. In the long run, though, the trend could generate huge benefits in Asia, which remains overly fixated on exchange rates.

Asian governments have been pumping up their economies for years by holding down currencies. The export-your-way to prosperity strategy has worked marvelously. But now that Asia is growing and stock markets are rising, it is time to try another approach and get out of the trap of export dependence.

Rising currencies are a sign of confidence in an economy, not a problem. The capital they bring in can be more important than the increased trade afforded by softer ones. Holding down currencies to bolster boost growth distracts economies from fixing their real problems.

It also delays the correction of one of the world’s most dangerous bubbles - the U.S. current-account deficit. Many analysts think that a weaker dollar is necessary to narrow the gap.

Finally, countries require healthy currencies to support stock markets that are playing unprecedented roles in economies. They are needed to hold down interest rates, too. That stimulates growth and helps companies raise money in the bond market instead of borrowing from banks. Asia is trying to broaden bond markets; here is a way to accelerate the process.

What signs should investors, who are wondering when Asia will buy fewer dollars, be looking for? For one, the end of currency pegs in the region, which would give central banks less reason to hoard dollars. Currencies officially pegged to the dollar include the Chinese yuan, the Hong Kong dollar and the Malaysian ringgit; de facto ones include the yen.

Tokyo has a certain target exchange rate in mind and last year it spent more than ?20 trillion, or $186 billion, trying to restrain the yen’s appreciation. Such unprecedented yen sales by the Bank of Japan are raising eyebrows in Frankfurt and elsewhere in Europe. It wouldn’t be surprising to see Japanese officials come under more pressure in 2004 to stop manipulating their currency at the expense of European growth.

While the dollar remains the world’s primary reserve currency, the euro’s success is gaining attention in Asia, where economists talk more and more about adopting a common currency. Yet that hasn’t translated into the kind of euro buying that might end the dollar’s reign.

The dollar, for better or worse, remains the currency of choice in Asia. The euro may indeed be No.1 someday soon, but not until this region gives its blessing.

  

Posted on January 13th, 2004 by jl
Filed under: Intl Financial System