A growing number of countries are intervening in currency markets amid growing frustration with the slumping U.S. dollar and China's refusal to absorb any of the readjustment in foreign exchange rates.
Reports indicated that at least four of China's main competitors in Southeast Asia bought dollars Monday to counter international investors' appetite for higher-yielding assets than can be found in the United States, where the Federal Reserve is expected to keep its benchmark lending rate near zero until well into the second half of this year.
The list included India, South Korea, Singapore and Indonesia – big trading nations that risk losing ground to China as the dollar falls because that country has insisted on tying the value of its currency to the greenback since 2008 to shield its economy from the global recession.
While the slumping dollar is the trigger for choppy currency markets, China is becoming an equally important source of instability because it is not absorbing its share of a wider adjustment as investors allocate funds to faster-growing and more stable economies than the U.S., which is struggling more than most to recover from recession.
China reported on the weekend that exports rose for the first time in 14 months, while imports surged to a record, reinforcing its status as the strongest economy in the world. Currency traders would love to get a piece of the action, but they can't because of various restrictions on investment and the government's accumulation of foreign exchange reserves, which is the government's main tool for anchoring the yuan's value against the dollar.
Many analysts say China's strategy is a classic “beggar-thy-neighbour” policy that protects domestic interests at the expense of other countries. The risk for the global economy is a domino effect that further distorts foreign exchange rates and global trade, impeding the recovery from the deepest global recession since the Second World War.
“It's a good question whether China is trading domestic stability for international instability,” said Daniel Schwanen, an economist at the Waterloo, Ont.-based Centre for International Governance Innovation. “It's one thing to intervene to stabilize fluctuations in your currency. It's another thing to intervene to gain this kind of competitive advantage.”
The interventions by Asian central banks came as the dollar fell to its lowest level in three weeks against the euro, ending a relative calm in international currency markets that set in over the Christmas holiday period as the greenback stabilized.
Confidence in the dollar crumbled over the weekend as traders digested a Jan. 8 report that showed the U.S. economy lost 85,000 jobs in December, increasing speculation that the Fed would have to leave interest rates low to bring about a sustained recovery.
South Korea's won has gained 4 per cent this month and Indonesia's rupiah has increased 3 per cent. Authorities in both countries warned Monday that they are prepared to keep up their interventions.
“We are worried that the foreign exchange market is leaning excessively one way,” Kim Ik-joo, head of the South Korean Finance Ministry's international finance bureau, told Reuters in an interview. “We are closely watching foreign exchange rates and we will take proper measures if necessary.”
Singapore and state-run banks in India also were buying dollars Monday, Reuters said, citing traders.
It's not just an Asian issue. Israel's central bank has intervened in currency markets, and the head of the Swiss National Bank warned Monday that he was prepared to block the franc from rising too high.
There is a feeling in financial markets that China will relent in the second half of the year, said Win Thin, a senior currency strategist at Brown Brother Harriman in New York. Forward contracts linked to the value of the Chinese currency imply an appreciation of more than 3 per cent, Mr. Thin said.
“The signals are that once the recovery in China takes hold, they will start to let the yuan rise,” Mr. Thin said. “They need to see a sustainable, private-led recovery worldwide.”
The risk is that won't happen soon enough. Foreign exchange rates are putting a strain on the Group of 20 nations, whose commitment to an orchestrated stimulus plan last year reversed the recession and renewed confidence in financial markets. They pledged to work this year on a program that would seek to avoid domestic policies that threaten the stability of the global economy, including foreign exchange rates.
Finance Minister Jim Flaherty said currencies would be an issue at meetings of the smaller Group of Seven and the G20. Mr. Flaherty hosts a meeting of G7 finance chiefs in Iqaluit next month, and Canada and South Korea will share the chairmanship of the G20.
“There was more movement in some of the Asian currencies before some of the economic crisis. There has been less movement during the economic crisis,” Mr. Flaherty told reporters Monday in St. Boniface, Man.
“Ultimately we would like to see more movement.”