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Citigroup will have fewer employees to rig markets with
By Chris Giles, Economics Editor
Financial Times, London
Saturday, February 26, 2005
http://news.ft.com/cms/s/06037bfe-87a1-11d9-ab48-00000e2511c8.html
Remember these names. Toshihiko Fukui. Zhou Xiaochuan. Perng Fai-
Nan. Park Seung. Joseph Yam. And Yaga Venugopal Reddy. They are the
central bank governors of Japan, China, Taiwan, South Korea, Hong
Kong and India respectively. They are also arguably more important
for US monetary policy than Alan Greenspan, the Federal Reserve
chairman, or his successor who will take on the role next year.
The argument is not as outlandish as it might seem. Consider some
evidence: When Mr Greenspan said the US trade deficit was
"increasingly less tenable" last November, financial markets
took fright. The Dow Jones Industrial index fell 115 points and the
dollar fell by 0.4 percent against the euro on foreign exchange
markets.
When a Bank of Korea spokesman implied on Monday that Korea wanted
gradually to shift its reserves away from the dollar, it sent
markets into a much larger tailspin. On Tuesday, the Dow plunged by
174 points and the US dollar fell 1.4 percent against the euro.
The evidence is not conclusive. But if the mere hint that South
Korea might stop buying US dollar assets can move edgy markets more
than Mr Greenspan's most trenchant comments to date on US deficits,
it signifies how far the balance of power in the global economy has
changed.
The statistics tell the story. The US must attract roughly $2
billion (1 billion) capital a day to finance its current account
deficit. This has to come either from private investors or foreign
governments. If not, the dollar would fall. In the past two years,
the reliance on official purchases of US assets from Asian central
banks has been enormous, and Asian central bank foreign exchange
reserves have swelled.
Japan's official exchange reserves now exceed $800 billion; China
holds more than $600 billion; Taiwan and South Korea each holds more
than $200 billion; and Hong Kong and India are not far behind.
Central banks are traditionally wary about revealing the proportion
of their reserves held in US dollar assets, but the Bank for
International Settlements, the "central bankers' bank," estimated
that just over two-thirds of total central bank foreign exchange
reserves were held in dollars at the end of 2003. A further
indication of the US reliance on foreign governments can be seen in
holdings of US government bonds. The US Bond Market Association
estimates that foreigners held 46.8 percent of US treasuries in
2004 compared with only 20 percent in 1990.
So why should we pay so much attention to the six leading central
bank governors in Asia? Quite simply because if any one of them
decided to diversify his country's exchange reserves aggressively
out of dollars, the kind of currency market jitters we saw this week
would pale into insignificance. Furthermore, if Asian central banks
merely decide to follow South Korea in ceasing to buy new US assets,
economists estimate that the interest rate on long-dated treasuries
could rise by 0.4 to 2 percentage points.
In short, one of the main drivers of monetary conditions in the US
is the Asian central banker.
At present these banks have a strong incentive not to rock the boat.
Any significant revaluation of an Asian currency against the dollar
would blow a huge hole in their public finances because they hold
hundreds of billions of dollars worth of foreign exchange reserves.
The situation is not sustainable. It resembles a giant pyramid
selling scheme. The US current account deficit is unlikely to shrink
in the next few years so, unless foreign private investors have a
change of heart, Asian central banks will have to keep buying dollar-
based assets to prevent their currencies rising and avoid the
consequent capital losses on their reserves.
As their exposure rises, the incentive to seek an exit will also
grow. Quietly and slowly, the medium-sized Asian central banks are
likely to try to diversify their portfolios of foreign exchange
reserves to limit their potential liabilities. But even China will
have a point when it is no longer willing to offer cheap loans to
the US. After this, all bets would be off. If a crisis ensued it
would be a disaster for Asia, which would suffer huge capital losses
and possibly an uncontrolled appreciation of local currencies. The
US would suffer higher interest rates and possibly a sharp slowdown
in growth as cheap finance dried up and the US consumer began to
save again. And Europe would not escape, as it is too dependent on
the rapid growth of the US and Asian economies.
The only solution is a concerted attempt to unwind the imbalances
that have slowly developed between the three main global economic
blocs. As Mervyn King, the Bank of England governor, said this
month: "It is ... meaningless to try to identify the culprit, and
blame any one bloc's woes on another." The conditions that have
created the fragility in the international monetary system at one
point suited all the economic areas for domestic reasons. But this
favourable situation cannot last forever.
So here is a plan for George W. Bush, "the leader of the Free
World." Learn from your successful smoothing of ruffled feathers in
Europe this week. Take a trip around Asia's central banks; do not
blame the current fragility on their deficient exchange rate
regimes, but seek to start a dialogue in which everyone understands
their responsibility for creating the current nervousness in
international capital markets. Then work on an agreed solution. As a
sign of the new transatlantic rapprochement, you could even take
Jean-Claude Trichet, the European Central Bank president, with you.
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