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Why does the value of the Korean won fluctuate?

Currency trading is greatly influenced by sentiment - market expectations.

Mar 26,2009
The won recently depreciated to 1,600 won against the American dollar and then recovered to 1,400 won.

It is hard to see this as a sign of stabilizing because the exchange rate of the won fluctuates so much. It can climb and fall sometimes hundreds of won in a day.

This year, the won’s performance was weak compared to the currencies of other Asian countries, including Malaysia and Thailand.

At one point, it fell as low as those of the poorest eastern European countries.

Many ask why the won has fallen so low, lower than during the Asian financial crisis in the late 1990s, when the country is supposedly doing better economically now than a decade ago.

To understand this situation, we have to understand that the currency market is closely connected to the stock market.

The currency market has moved in the same direction as the stock market on several occasions in the past few weeks.

In other words, when stock prices go down, the currency depreciates, and vice versa.

Foreign investors have a big influence over Korea’s stock markets. They own around 28 percent of stocks traded on the Korean stock markets at present. Last year alone, foreigners sold $41.2 billion worth of Korean stocks. The money they receive when they sell these stocks is converted from won to dollars.

The currency market is a place where the law of supply and demand applies: if there is a lot of dollars up for sale, the dollar’s value falls and the won goes up. Thus, if there is a lack of dollars in the market, the dollar goes up and the won goes down.

Because foreigners recently started selling stock and getting their money in dollars, the Korean stock market has been going down, which also resulted in the depreciation of the won.

Foreigners are selling their Korean stocks because the world economy is so unstable due to the financial crisis.

The crisis, which started in the United States, has created problems for many businesses here and abroad. As a result, companies around the globe have started withdrawing investments and taking their money back - in dollars.

The prevailing sentiment now is to take money out of riskier places and invest where it is safer.

In the eyes of foreign investors, Korea and other emerging markets are riskier places to invest compared to more economically developed countries.

Moreover, Korea’s economy relies heavily on exports; with the global economy slowing and overseas demand decreasing, Korea’s export performance is affected negatively.

But the depreciation of the won is not only due to stock selling by foreign investors. If there were enough dollars in the market in the first place, when these foreign investors went to sell their stock, the value of the won wouldn’t have gone down so much.

When the won depreciates, the prices of imports here go up. Thus, the price of an imported car, for example, will go up accordingly. Even though the original price of the car in dollars stays the same, more won is needed to buy it because the won’s value has gone down.

This is why imported cars in Korea are not selling well at the moment.

In contrast, Korean companies have an advantage when exporting to other countries. If a Korean-made product is priced at 100,000 won when the won/dollar value is 1,000 won (per dollar), this would sell at $100 in the U.S.

However, if the exchange rate is 1,500 won to the dollar, the same product will go for $67.

During the Asian financial crisis, this situation worked to the country’s advantage. In 1998, Korea had a trade surplus of over $40 billion. If the country sees a trade surplus, it will earn more dollars. This, ultimately, raises the value of the won.

Since global oil prices have been unstable too, Korea’s import costs for energy, including crude oil and gas, have jumped from $82.8 billion in 2007 to $123.6 billion last year.

Also, the total amount of money spent by Koreans traveling overseas was $800 million more than the amount that foreign visitors spent in Korea. Koreans spent more dollars abroad compared to tourist dollars earned here.

In addition, Korean banks had to borrow money last year from foreign financial institutions to pay for loans in dollars, which made the situation even worse for us.

Local banks borrowed money from overseas when the real estate market in Korea was thriving and then lent the money here.

But just as payment for many of those overseas loans were coming due the global economic crisis broke out. When overseas loans mature, Korean banks have to repay the loans in dollars at a time when local businesses are reeling from increased costs and falling revenue.

These banks eventually paid back the loans they borrowed from foreign banks with help from the Bank of Korea and the government.

Another problem is that the local currency market is not very big. At present, the average amount of daily currency trading in Seoul is around $3 billion to $4 billion.

Because this market is so small, even a small change will have a big influence in deciding the won’s value. In such a market, speculative buying of stocks for short-term profit happens a lot.

This is when people buy dollars even though they don’t need them, to stockpile dollars to finance their business or so they can sell them back when the dollar rises in value.

When this happens, the government may decide to intervene to stabilize the currency exchange by using some of the country’s foreign currency reserves to defend the value of the won. Korea at the moment has over $200 billion worth of foreign currency reserves.

Even government intervention can’t fully control currency values. If foreign investors leave Korea because they think the economy here will get worse, government efforts will be in vain.

And worse, the foreign currency that the government placed in the market will not be able to stabilize the won. Because of these, financial experts agree that government intervention in the currency market should be kept to a minimum.


By Kim Won-bae [jainnie@joongang.co.kr]


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