Foreign Exchange Market

Asia central banks live in greenback dream

PUBLISHED : Thursday, 15 January, 2004, 12:00am
UPDATED : Thursday, 15 January, 2004, 12:00am

THE REST OF the world may be shaking itself loose of a long fascination with the US dollar but Asian countries are a long way yet from letting go of their dollar fixes.

Just look at the performance of the euro against the dollar since the greenback reached the peak of its strength at the end of January two years ago. That is the red line in the first chart, up 48.6 per cent against the dollar over the period.

Now look at the blue line in the chart. It represents a weighted average of Asian currencies against the dollar, excluding the yen. It is up 6.5 per cent against the dollar over the period and most of that paltry strength was registered in the first half of 2002. Since then Asian currencies on balance have not moved up against the dollar at all.

The bar chart tells you the same story on a country-by-country basis. On the top, you have the world's major currencies, all up strongly against the dollar. Then you get Asia outside of Japan.

Granted that the Indonesian rupiah has also shown considerable strength over the past two years but remember that no currency in Asia plummeted quite as far as the rupiah did in the Asian financial crisis of 1997-98. It now stands at 8,320 to the dollar. In June 1997 that figure was 2,450. As they say in the stock market, even a dead cat will bounce if dropped from the top of the tallest tower in town.

The strength of the Thai baht, next down the list, is actually very little in a climate of US dollar weakness, given the strong recovery of the Thai economy recently and the fact that the baht, like the rupiah, also collapsed in the financial crisis. Much the same can be said of the South Korean won.

And then you get Hong Kong, China and Malaysia at the bottom of the bar chart - no real movement against the US dollar at all - and the Philippines, where the peso has actually continued to weaken against the dollar. Yes, I know that prolonged peso strength against the dollar is about as likely as a moon made of blue cheese. It is still worth noting.

It all seems unusual on several counts. In the first place, purchasing power parity studies, which attempt to calculate what a currency's exchange value would be against the dollar if prices for goods in that currency were equivalent to prices in the US, all suggest that Asian currencies should be stronger. In China's case some of these studies have indicated that the yuan should be up to three times as strong as it is.

On a more immediate basis, underlying currency movements are determined by movements in the balance of payments and countries that show big current account surpluses in general have stronger currencies. Asian current accounts are almost all strongly in surplus. The regional average is equivalent to about 6 per cent of gross domestic product, which is a high number and should ordinarily have produced currency strength long ago.

It does not always work that way, of course. There can be good reasons why foreign investment money still shuns countries with big current account surpluses and then currency weakness will still exist.

That has been the trend in Asia in recent years. The US dollar has consistently been seen as a more attractive currency.

But it is becoming increasingly difficult to support this view with recent US dollar weakness, despite massive inflows of capital to the US and with prospects of more weakness to come.

In the end, the feeble performance of Asian currencies against the US dollar is probably attributable to Asian central bankers who still want things this way and these are people who do not always act in the most rational manner.

If so, and it appears likely to be so, then we could be living in a fool's paradise in this part of the world. We had that sort of paradise before the bubble burst across the region in mid-1997. It may not burst with quite so big a bang this time but the longer that natural forces are defied the bigger the bang could be.