ASIAN CENTRAL BANKERS AFFECTING MARKETS

[Anonymous]

Asian Central Bankers Affecting
Markets
NEW YORK – Most American investors have never heard of Park
Seung, but he might have more influence over your portfolio than you think. He’s
the governor of the Bank of Korea – the Alan Greenspan of Seoul – and a line
from a statement issued by his office this past week helped send U.S. stocks to
their biggest one-day plunge since May 2003.


The
suggestion that South Korea might diversify its currency holdings away
from the greenback-later retracted- also rattled the bond market,
sending interest rates higher and the price of dollar-denominated
assets like gold and oil soaring.

The incident underscored the
vulnerability of the dollar and exposed cracks in the U.S. currency policy,an
issue analysts say is getting harder to ignore. It also suggests that if current
conditions persists, more rough trading days lie ahead.

It’s the butterfly effect. All these markets are very
intertwined, and events you think should have no impact on your portfolio
suddenly do,” said Kenneth McCarthy, chief economist at the Center for
Innovative Entrepreneurship, a non-profit group.

The dollar
has served as a reserve currency for much of the world since World War II, but
its nearly-three year decline has led many central banks to consider
diversifying into other types of money, especially in the face of a more
valuable euro. What’s stopping them, analysts say, is that a sharp decline in
the dollar would have a cataclysmic effect on the U.S. economy, which could dry
up the market for Asian-made goods.

“I think
this question of diversifying out of the dollar is on the minds of many central
banks, but they don’t want to say it,” McCarthy said. “The last thing you want
to do is trigger a sell-off of the dollar. Nobody wants to do that.”

For America,
a hearty foreign appetite for U.S. assets and debt is critical to help cover the
record-high current account deficit. Some 43 percent of all U.S. Treasuries and
bonds are held by foreigners. But economists, even Greenspan himself, have
worried that at some point the central banks – particularly those in Asia, the
biggest investors in U.S. debt – might start selling U.S. dollars.

This isn’t a
new concern. But when South Korea, with the world’s fourth-largest foreign
exchange reserve, said in a parliamentary report it might consider diversifying
its currency holdings, it caused “a panic in the markets,” McCarthy said, as
large hedge funds and other powerful speculators rushed to take advantage of the
situation.

In the
resulting frenzy Tuesday, the dollar, which had been on the rise and seemed to
be stabilizing, plunged, giving incentive to anyone who wanted to sell, and
launching programmed trades for those who had shorted it. Oil prices surged as
market participants bet the Organization of Petroleum Exporting Countries might
cut production at its meeting next month in order to raise crude prices and
offset the decline of the dollar. The cartel’s president has said this is
unlikely; oil prices are already 50 percent higher than they were a year ago,
despite the fact that domestic fuel supplies are well above last year’s levels.

South
Korea’s central bank governor attempted to clarify his country’s position in the
ensuing days, saying it had no plans to sell existing dollar assets, though it
might use new reserves to diversify into British pounds or Canadian dollars.
Japanese finance officials said they weren’t planning major changes to their
currency asset mix, either.

The bottom
line, analysts say, is that Tuesday’s trading was mostly driven by speculation.
But while the panic has subsided, and stocks have recouped some of their losses,
the event has resonated among market watchers. Some economists say that even if
Korea makes only marginal changes, it could have significant ripple effects. The
market’s reaction on Tuesday serves as a further signal that the current
arrangement – relying on Asian central banks to forestall the dollar’s slide –
is unsustainable.

If central
banks in Japan, Taiwan and Korea all made changes at once, some analysts argue,
it could cause China to re-evaluate its currency policy, because it would wind
up having to buy even more dollars than it does now to maintain the yuan’s peg
to the U.S. currency. In this regard, China has “painted itself into a
corner,” said Peter Morici, a business professor at the University of Maryland.

“This is
the way a currency crisis begins,” Morici said. “Several countries are
involved in maintaining an overvalued dollar, and if Korea moves, it imposes
costs on China and other countries also buying dollars. So even at the margin,
this will cause other countries to re-evaluate their position, and as each pulls
away, China will be faced with a larger and larger bill.”

What makes
China “the kingpin,” in the situation, Morici said, is that it has been the
most active in buying U.S. debt. As of last year, China was spending 12 percent
of its gross domestic product on foreign securites – much of it U.S. assets.

It’s
unlikely China will dump its dollar reserves, Morici said, because that would
cause a financial crisis that would disrupt its trade with the United States,
cause massive unemployment in China and ultimately threaten the stability of the
communist regime. But sooner or later, China will have to take steps to revalue
its currency.

Over the
long term, that could bring higher interest rates in the United States, and in
turn, declines in the housing market. In the short term, speculation about what
lies ahead will likely mean more volatility in stocks. For small investors, the
best way to deal with it is to stand firm, McCarthy said.

“Over the
longer term, the values of equities are going to be determined by the value of
the underlying company and their ability to deliver earnings. And although it’s
upsetting to the market when these kinds of macro things happen, that’s not the
time to sell,” McCarthy said. “What investors need to pay attention to, in the
long run, are those fundamentals, and not the day-to-day jumps. You may end up
eating more Tums, but basically … you should continue your strategy.”

[Author]

March 3, 2005 at 10:09 AM