Keith W. Rabin and Scott B. MacDonald
International currency markets remain on edge, worried
about the future trajectory of the U.S. dollar
and its impact on other major currencies and
economies. This concern is compounded by apprehension
over what is on the minds of Asian central bankers,
who collectively held a combined $2.3 trillion
in U.S. dollar reserves at the end of last year.
by the Bank of Korea and Japanese Prime Minister earlier
this year conveying their
intention to diversify reserves away from the
U.S. dollar rang alarm bells in world financial
markets. In recent weeks, however, this anxiety
has declined, as the US$ has begun to strengthen,
and Treasury Department data reveals that foreign
investors bought $91.5 billion in Treasury
notes, corporate bonds, stocks and other financial assets
in January – nearly a 50% increase over
concern over dollar holdings in any case should be surprising
given that a move
toward greater central bank currency diversification
is inevitable over the longer term. Brazil,
Russia, India, China and other emerging economies are
expected to grow far more rapidly than the
States in coming decades. Therefore, the
U.S. share of global GDP, and the relative importance
of its economy, should decline over time.
Japan, another mature economy, is likely
to show less dependence and correlation to the U.S. moving
forward. This is due to increasing demand
Asia as well as ongoing restructuring and
the gradual awakening of the Japanese consumer.
the possibility of a systemic shock cannot
dismissed, it is unlikely this will be
due to an abrupt decline in Asian U.S. dollar holdings.
The shift toward diversification is not
to be as fast or traumatic as many forecasters
indicate. For one thing, at the present
time, it is unclear whether any alternative currencies
have sufficient depth and liquidity to
inflows of such magnitude. In addition,
any rapid move by Asian central banks to diversify from
the US$ would serve only to strengthen
respective currencies against the dollar.
Their export competitiveness would decline as a result – as
would the large amounts of U.S. Treasury Agency
securities already in their portfolios – when
translated back into the domestic currency in
question. As of last December, Japan alone held
almost $712, China $194 and Korea $69 billion.
if one were to believe that Asian economies could withstand
the significant financial ramifications
of an overt move away from the U.S. dollar,
it is doubtful they would move to do so. The alliances
that bind the U.S. to playing a vital
role in that part of the world are becoming
increasingly important – at a time when we are seeing
increasing signs that the delicate balance that
has kept the region relatively tranquil for several
decades is starting to become undone. Chinese
submarines off the coast of, territorial disputes
with, and violent demonstrations against, a Japan
more prone to asserting its military power, nuclear
tensions with North Korea, several border disputes
and saber rattling over Taiwan, are just a few
of many issues rising in prominence.
is not to suggest the existance of a strong quid
pro quo, in which U.S. and Asian leaders
are closely coordinating and linking economic with
security considerations. Rather, as
CLSA analyst Christopher Wood highlighted in a recent
a recognition is developing that “there
is clearly a ‘rearmament dynamic’ at
work in the East Asian region in the sense that
the post-1945 status quo is over”.
China moves to augment, upgrade and flaunt its military
capabilities and to achieve more
political stature, Japan, South Korea,
and Taiwan, which depend on the U.S. as guarantors of
security, are unlikely to take any
steps that might endanger Washington’s ability to
sustain its treaty and alliance commitments.
Nations such as Thailand and others in Southeast
Asia, who also hold significant amounts of U.S.
Treasury securities, also benefit from the ability
of the U.S. to serve as a counterweight as China
continues to transition into an increasingly
powerful world leader.
might also imagine China reluctant to see an economically
U.S., pressured to cut back on
its security commitments. Such a move would create a
number of extremely
complicated diplomatic issues and
dramatically raise anxiety levels throughout the region.
would make it far more difficult
for China to maintain its focus on domestic development,
well as efforts to position itself
as the focal point of an integrated, and more financially
independent, Asia. To cite one
example, a reduced
U.S. security presence would increase
pressure on China to lead in resolving an already intractable
situation in North Korea, a responsibility
has been reluctant to assume.
economic reasons why Asian central banks will refrain
the U.S. dollar will diminish
over time as regional growth and integration accelerates.
enhance domestic consumption
demand, as well as a greater emphasis on the services
This will serve to alleviate
dependence on exports and create an increasingly
vibrant and attractive new driver of global growth
progress in Asia, however, bolstered by regional integration,
on the shared sense of national
security and confidence necessary to allow sufficient
Given the diverse range of
interests, as well as the numerous wars, skirmishes,
and power struggles
that have held back development
in Asia to the present time, the importance of a U.S.
presence should not be minimized.
reluctance of Asian economies to abandon the U.S. dollar
might be seen as a key reason
why the U.S. bond market has been maintaining its strength,
the U.S. dollar -- which
been showing renewed strength in recent weeks -- may
not be ready
to reverse itself in a precipitous
slide – despite
renewed signs of weakness and the existence of
numerous troubling indicators.
should be emphasized, however, that the willingness of
banks to maintain their
U.S. dollar holdings does not offer a solution to growing
in the U.S. and related
distortions in the global financial system. At best,
it only delays --
the risk of systemic shocks,
as well as implementation of the structural adjustments
necessary to resolve
U.S. and Asian interests remain in lockstep and the
is likely to sustain
itself for the foreseeable future. This is something
need to remember. At
the same time, questionings of this reasoning promise
no end to market volatility.
In addition, the potential for an abrupt end to this
game of musical
chairs should not be
discounted. This is true regardless of whether Asian
their ongoing love affair with
the U.S. dollar.
W. Rabin is President of KWR International
B. MacDonald is Senior Managing Director at Aladdin
Capital and a Senior Consultant at KWR International