Friday, January 16, 2004

Dollar Follies

The Euro is steadily retreating from previous highs. But, this Buttonwood column in the latest Economist is enough to give Adam Yoshida his final psychotic break.

Japan’s foreign-exchange reserves now amount to $674 billion, more than any other country has ever amassed, and far more than could be needed to guard against the sorts of things that forex reserves are traditionally used for, such as having the wherewithal to pay bills in extremis to foreign creditors. No, the Bank of Japan, unlike John Snow, America’s treasury secretary, really does believe in a strong dollar policy and is prepared to put its money where its mouth is. As, indeed, have central banks almost everywhere in Asia, not least China’s. The region’s foreign-exchange reserves now amount to $1.8 trillion, a tidy sum. Together with Japan’s central bank, the People’s Bank of China financed half of America’s current-account deficit last year. But they are buying assets in a currency that is steadily losing its worth as a store of value, which should presumably be set against any possible advantages for their exporters.

This unprecedented situation is neatly described by David Bowers, a strategist at Merrill Lynch, as the “mother of all vendor-financing deals”. In essence, Asian central banks are lending Americans cheap money (via their purchases of Treasury bonds) to buy Asian products. Mercantilism, it is clear, is alive and well. Thus, in one sense, have Asian countries ignored the lessons of their financial crisis in 1997-98, which erupted in large part because they tried to peg their currencies to the dollar to keep exports strong—and damn the long-term consequences.

Those consequences are becoming increasingly clear, starting in China, which has a fixed exchange rate. All those Treasuries it has been buying have to be converted into the yuan, the local currency. This boosts the country’s money supply and causes inflation. Speculation in one form or another, notably in property, is rife—the last thing a country with an already shaky financial system needs.

As goes China, so goes the rest of the region. At what point does a healthy dose of reflation become another bubble? At some point, it will start to dawn on Asian countries that domestic demand and exports to one another are just as important as exporting to America, and they will stop intervening. That will probably mean that their currencies appreciate against the dollar—though that is far from certain.

...I've always been a bit curious about libertarians' (small l) takes on both central banks and currency market interventions...