If Andy Xie of Morgan Stanley is right, the Koreans are going to have one hell of a time keeping the won down against the renminbi -- and the dollar -- this year.
The current wave of excitement centers on Korea. When the Korean market was doing well late last year, many international investors did not follow. Almost all money managers are now believers in Korea now. Most money managers believe in a strong recovery in Korea's domestic demand and the rest believe in interest rates declining. The same arguments explaining Korea's problems have come back. For example, the high level of household debt is just a data problem. Everyone seems to have a good reason to be in Korea.We already know that Korea has battled mightily against won appreciation over the past two years, with the Bank of Korea's foreign reserves growing 27% since January 2004 and a stunning 62% since January 2003. And yet the won continues to rise. In early April 2003 the dollar bought around 1260 won; now it buys less than 1030 won, a nearly 20% appreciation. Over the same period the yen has gone up 13% and the Taiwanese dollar up around 10%.
Korea is just the latest example of a liquidity bubble touching a market. A liquidity bubble needs a focal point to turn into higher asset prices. In my view, Korea is serving this purpose now. The changes in domestic funds flow due to government policies drove the market last year. The momentum sucked in retail investors and became stronger. The international investors are just jumping on this bandwagon.
While Japan and China -- for different reasons -- have the ability to eat and eat and eat US assets, Korea is a much smaller player which has already gorged itself on dollar securities to little avail. Might Korea be an important weak spot in the East Asian dollar bloc? If Andy Xie is right, we may find out in the ensuing months.
UPDATE: No sooner had I published this posting when I ran across this story in Bloomberg today. It appears things may be moving faster than either Xie or I had imagined.
South Korea's central bank, which has a total $200 billion in reserves, said in a report to a parliamentary committee on Feb. 18 that it will increase investments in assets denominated in currencies such as the Australian and Canadian dollars. Korean investors, including the central bank, are the fifth-biggest foreign holders of U.S. Treasuries.UPDATE 2: As expected, the Korean won shot up today on news that the Bank of Korea plans on pulling back from the dollar bar. As of 4:37pm EST according to Oanda, the won is up 1.2% over yesterday versus the dollar/renminbi, 1.1% versus the yen, and 0.7% versus the Taiwan dollar. Now the real interesting part comes. How long can Korea stand the pain?
``Support for the dollar is quickly disappearing,'' said Kenichiro Ikezawa, who manages $1 billion in overseas debt at Daiwa SB Investments in Tokyo. ``This Korean story is having quite an impact because it feeds into suspicion that others are also seeking to cut their exposure to the dollar.'' . . .
The report, distributed to members of the parliament's finance and economy committee in advance of a debate scheduled for Feb. 24, also said the bank will expand investments into assets with lower credit ratings than the South Korean government. . . .
``South Korea wants to start picking up higher yields so that includes moves in to the Australian currency and sterling, and they'll be buying government bonds,'' said Austin.