Sunday, February 22, 2009

The Debts of the Lenders: Asian Nations Form Reserve Currency Pool

So, it's finally happened. A group of Asian nations - Japan, China, South Korea and 10 Southeast Asian nations - agreed to form a reserve currency pool to protect the more vulnerable currencies from speculative attacks.

The group consists of two sides: cash rich nations and cash poor nations. China, Japan, Singapore, and (arguably) Taiwan comprise the group w/deep pockets filled w/US treasuries. Everyone else consists of cash poor nations that are prone to political and economic upheaval - which basically includes all of southeast Asia (w/the prior exception of Singapore) and S. Korea.

Why would countries like Japan and China agree to fund the functional equivalent of pan-Asian bailouts?

Remember, the export driven, factory nations of the Far East need weaker currencies against their major trade partners (traditionally a stronger dollar but that has grown to encompass the Euro as well). Funding such bailouts are a hidden way of depreciating their own currencies - even though analysts were quick to defend the new agreement:

“This fund is not aimed at avoiding a region-wide simultaneous depreciation,” said Sebastien Barbe, a strategist at Calyon in Hong Kong, the investment banking unit of France’s Credit Agricole SA. If “the aim is to avoid a currency crisis if one or two member countries are under extreme pressure, then the fund can be used to avoid a currency crisis,” he said.

To be fair, Treasury rich Asian nations are trying to fulfill the traditional role of Western money, that is to support capital flows that had been abruptly slowed or even cut off last autumn. Southeast Asia and S. Korea were hit particularly hard as foreign investors began withdrawing funds from the sovereign debt (mutual funds), corporate equity markets (mutual funds again), and individual project finance deals (hedgies).

Sovereign reserves declined substantially in attempts to defend the currency from speculative attacks and led to increased demand for dollars (the international reserve currency of choice remains the dollar). The stronger dollar in turn negatively impacted trade deficits and led to further weakening of export driven sectors - particularly in manufacturing and shipping. This is a vicious cycle that is still ongoing but finance ministers apparently believe this new economic framework can lead to regional stability.

On a more practical level, the implementation of such a reserve currency scheme means that the yen is no longer the attractive safe haven it used to be. Instead, the flight to safety has found new legs in other asset classes such as precious metals.


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