When the well runs dry
Currencies in the Asia-Pacific region are tumbling despite strong government finances and resilient exports. Such strengths fade in significance when the investors once lured by them become so weak they’re forced to cash out. Asian economies that hoarded their export dollars can more easily weather the drought. But those that have a smaller dollar stash, like Australia and South Korea, face a potential greenback shortage and more dramatic currency swoons.
These vulnerabilities are evident in the currency market: in the past two months of market turmoil, the Korean won, the New Zealand dollar and the Australian dollar have all fallen by roughly 10 percent against the U.S. dollar, making them the worst-performing currencies in the Pacific Rim.
What makes these more developed economies so vulnerable? One factor is popularity. Strong economic growth, exports and government finances prompted global investors, many of them from Europe, to pour dollars into local stocks, bonds and loans. But with Europe’s finances looking shaky, those investors are now exchanging local currency for dollars at such a rate that central banks in Korea, Taiwan and Indonesia have started selling dollars to ease sharp declines in their own currencies.
For many countries, the retreat poses little problem: after facing a similar issue during the Asian financial crisis in the late 1990s, they accumulated huge foreign exchange reserves, both to keep their currencies from rising, and as insurance against this kind of stampede.
Korea has a sizeable trade surplus and $305 billion in foreign exchange reserves. But that’s only twice the amount of overseas debt it needs to pay back in the next two years. The risk is that the Bank of Korea runs down its reserves as investors leave, forcing the won even lower.
Australia and New Zealand have even lower reserve levels. Even though their central banks are unlikely to intervene to support the currencies, a rush for dollars could quickly sap their supply, driving currencies lower and sharply raising the cost of local credit. The same problem forced Australia to pump cash into its banking system during the 2008 crisis even though it wasn’t directly exposed to the mess in Europe or the United States. When it comes to global capital, an ebbing tide sinks all boats.