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 user 2005-03-03 at 10:07:00 am Views: 58
  • #10633
    Asian Central Bankers Affecting

    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

    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.

    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.

    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.”