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Asian Economy

Asia fills her boots: dollar reserves skyrocket
By John Berthelsen

At a time when the United States remains tightly focused on its domestic economic problems and its international military adventures of the past two years, Asia has been quietly running up an absolutely staggering surplus of US dollars.

By the end of 2003, according to JP Morgan Chase economists in Hong Kong, the combined countries of Asia are expected to hold an astonishing 70 percent of the world's currency reserves. In the past decade, they estimate, Asia has added US$1.2 trillion to its US dollar reserves as it runs up whopping trade surpluses with the rest of the world - principally the United States, whose annual trade deficit is expected to reach US$500 billion. Credit Lyonnais Securities Asia (CLSA) in Hong Kong put the Asian reserves even higher, at perhaps $1.5 trillion.

Is this a danger to the world economy? For many years, America's strong-dollar policy served the world and chiefly the United States very well. Their currencies cheap against the US dollar, Asian manufacturers profited by making relatively inexpensive exports and selling them in the United States at a healthy profit. In a kind cat-and-rat-farm analogy, in which the cats eat the rats, are skinned for their fur, and then are fed back to new rats, the Americans benefited by getting cheap goods that kept their consumer-led economy roaring. The financial communities benefited from the repatriation of those profits as the funds flowed back in a ceaseless waterfall into US stock markets, treasury and corporate bonds, money-market funds and other financial instruments.

But perpetual-motion machines don't work. The monumental scale of Asia's dollar reserves and the size of America's deficit are starting to make economists and strategists nervous. Wayne Godley, an economist at the Levy Economics Institute in New York, writes: "If the balance of trade does not improve, there is a danger that over a period of time the United States will find itself in a 'debt trap', with an accelerating deterioration both in its net foreign-asset position and in its overall current balance of payments (as net income paid abroad starts to explode). Such a trap would call imperatively for corrective action if it is not at some stage to unravel chaotically."

It has been widely reported that the US must take in about $1.3 billion a day - about $55 million an hour - in foreign investment to finance its overseas debt. If that river of money falters or dries up, the difference must be made up by an inexorable fall in the value of the US currency. Indeed, if it had stopped already, the fall in the US stock markets since equities began to lose their luster in 2000 would have been catastrophic.

Certainly, Asia has been on a buying spree in US securities of all types. Despite a three-year economic pause in the United States, Asians bought a record $201 billion worth of long-term US paper in 2002. That includes another record $97 billion in US government securities. Asian central banks, with their enormous overhangs of US dollars, are increasingly doing the buying.

Over the past months, US Treasury Secretary John W Snow has begun to try to talk the US dollar down. It had fallen by more than 25 percent against the euro, the Eurozone's common currency and the world's other reserve legal tender, before increasingly optimistic economic news and a rising stock market checked the dollar's fall. Although it has since risen against the euro by about 4 percent, many economists believe the dollar's precarious position will cause the slide to continue.

The currencies of Asia, however, have almost all remained firmly tied to the dollar, either through currency pegs, reserve boards or, as in the case of Japan, as governments have bought dollars to keep their currencies static and thus to preserve their terms of trade.

Despite the US attempts to talk the dollar down, Asian governments regard any negative changes in their trade balances as inimical to their economies. While supposedly loosening restrictions so that their consumers can participate in a demand-led consumer revolution, Asia in fact is more dependent on exports today than at any time over the past two decades.

China, whose share of exports in total gross domestic product (GDP) averaged 10.8 percent in 1985-89, now is producing exports at 28.4 percent of GDP. South Korea's exports were at 23 percent during the same period and now are at 54 percent of GDP. Hong Kong, then at 77.8 percent, is now at 153.5 percent of GDP. These figures are being repeated across virtually every economy in Asia. These exports continue to flow into the United States despite a three-year economic downturn that, if rationality were to prevail, should have slowed consumer purchases. The US Federal Reserve's easy-money policy and record cuts in interest rates, however, have kept consumers buying at a feverish pace, far too often on credit.

"So long as America continues to secure easy funding, there is no pressure on policymakers in Washington to do anything other than run super-easy policies to try to keep their own consumer credit cycle going," says Christopher Wood, global emerging-markets equities strategist for CLSA Hong Kong. "Like any profligate debtor, market discipline will only be imposed on America when foreign investors demand an interest-rate premium for owning dollars."

Wood tends to grow apocalyptic. "The current trend can continue for a while," he writes in his 110-page first-half 2003 overview of the world economy, published last month. "But the longer American excesses are financed, the more inevitable will be the ultimate collapse of the US paper-dollar standard that has been in place ever since Richard Nixon broke with Bretton Woods by ending the dollar's link with gold in 1971. The result will be a massive devaluation against gold of Asia's hoard of dollar-exchange reserves."

Japan's foreign reserves currently total $496 billion, followed by China at $310 billion and Taiwan at US$170 billion, according to figures compiled in April by the Hong Kong Monetary Authority. Hong Kong, with 7.5 million people, has reserves of $114 billion, nearly seven times the total money in circulation in the territory. Other Asian treasuries are similarly bulging with dollars.

In answer to statements by Treasury Secretary Snow that the country should let its currency float upward, China's central bank governor, Zhou Xiaochuan, said at the end of June that he sees no possibility that the yuan, which trades in a narrow band at about 8.28 to the dollar, would be revalued upward. Nor is there a possibility that it will rise against the currencies of any of its other major trading partners. China intends to eat everybody's lunch.

Confronting the prospect of additional economically difficult integration into the World Trade Organization, and faced with the task of creating tens of millions of jobs for its sacked state-owned-enterprise workers, China's leaders believe it is crucial to keep growth above 8 percent. Severe acute respiratory syndrome (SARS) took half a point off growth in March through June. President Hu Jintao and Prime Minister Wen Jiabao have demanded, under a policy statement called "Double Victory", that growth continue at the maximum possible rate. There is not the slightest intention to help the United States cure its trade-balance problem by either making US exports to China more attractive or raising the price of exports to the US.

Likewise, Japan, vainly attempting for the 13th year to export its way out of its economic quagmire, is keeping the yen within a range near 115 to the US dollar. Since the beginning of the year, the Bank of Japan is believed to have bought as much as $60 billion in US securities - $30 billion in March alone - to keep the yen where it is. Its purchases have been increasing at a record pace.

Asia does not have to follow this path, Christopher Wood of CLSA says. "Asian central banks could abandon their mercantilist policies. They could let their currencies rise, which is what would happen given Asia's high savings rates if market forces were allowed to prevail. This would in turn boost Asia's consumer demand cycle. This is also what should be happening from a theoretical standpoint, as satiated American consumers have already borrowed a lot and need to rebuild their balance sheets."

Then, turning truly apocalyptic, Wood predicts that by the end of the decade there will no longer be a possibility that the world's central banks can control the situation, and there will be a truly massive devaluation of the US dollar. "The view here is that the US dollar will have disintegrated by the end of this decade. By then, the target price of gold bullion is US$3,400 an ounce." That is roughly 10 times gold's current level. If that were to happen, Asia's holders of dollars would be forced to start selling them or see their own reserves collapse. If they start to sell them, the price of America's paper will fall even faster.

That is truly apocalypse now, or in 2010. Is it possible? The policymakers in the administration of President George W Bush in Washington are far more sanguine. They regard economists, often said to be the only field in which two individuals have shared the Nobel Prize for saying exactly the opposite things, to be basically irrelevant, and presumably by extension strategists. The administration, facing an election in a year and a half, and the Federal Reserve intend to keep the party going if they can.

(Copyright 2003 Asia Times Online Co, Ltd. All rights reserved. Please contact content@atimes.com for information on our sales and syndication policies.)
 
Jul 15, 2003



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