[VIEWPOINT]Central bank chief in spotlightIn recent years, Korea has sought to raise its global diplomatic profile, promoting, for example, a Korean candidacy for United Nations secretary-general. But in recent weeks, it appears that the nation may have inadvertently stumbled upon its first global diplomatic superstar in the unlikely form of Bank of Korea (BOK) Governor Park Seung.
Most people outside of Korea (and indeed many Koreans) would be hard pressed to name any of Governor Park’s predecessors. Yet after a BOK statement on Feb. 21 that it was considering diversifying future purchases away from U.S. Treasury bills, the U.S. dollar fell 1.4 percent against the euro and the Dow Jones index dropped 174 points.
How the mighty have fallen! After decades of the United States lecturing Korea on how to manage its currency, the irony was startling.
Nevertheless, the BOK statement also intimates why Koreans might want to go light on the schadenfreude. It is true that the forecasts are for the United States to run budget and current-account deficits as far as the eye can see, and consequently it is unlikely that there will be rapid resolution to the fundamental underlying macroeconomic imbalances in the United States that are contributing to the exchange market fragility.
Yet globally, two-thirds of official reserves are held in the form of dollar-denominated assets, mostly Treasury bills. Asian central banks hold about 60 percent of those reserves, with the BOK accounting for more than $200 billion. From a simple portfolio management perspective, some diversification away from dollar-denominated assets would seem to be in order. But in favor of what?
The BOK mentions several alternatives: the euro, the pound sterling, and the Canadian dollar. Movements in the loonie and greenback are highly correlated, so the portfolio diversification merits of heading north are questionable. Besides, the Canadian economy isn’t that much larger than the Korean economy: Too much loony diversification and the BOK could end up owning a large chunk of the Toronto Stock Exchange.
The mere mention of the Canadian dollar signals the obvious lacunae: the absence of any credible Asian currency candidate for would-be diversifiers. Despite occasional rhetoric to the contrary, Japan has never been willing to surrender the degree of sovereign control over monetary policy and financial markets that would be necessary to make the yen a reserve currency. The Chinese yuan remains non-convertible. And although regional cooperation is proceeding apace, the dawn of the Asian currency unit is still years away.
This situation sets up a series of potential conflicts. Medium central banks, such as the BOK, with large dollar holdings and fearing the currency’s collapse, face an incentive to be surreptitiously the proverbial first guy out the door.
Furthermore, the dearth of an Asian reserve currency sets up a clash between Asia and Europe: If Asian central banks, the predominate holders of official reserves, diversify out of U.S. dollars, it is likely to be into European currencies, thereby driving up the value of the European currencies, reducing export competitiveness, and almost surely contributing to mercantilist trade disputes between Europe and the rest of the world, Asia included. Given the comparative inflexibility of the European economies and their relative inability to redeploy resources from the production of internationally traded to non-traded goods and services, the net result would probably be a reduction in global growth.
One way of at least taking some of the pressure off the Asian central banks would be to revalue their currencies against the dollar, though any significant revaluation would generate capital losses of existing holdings of dollar-denominated assets.
One way of at least tempering the broader macroeconomic impact of such a policy would be to execute the revaluation in a regionally coordinated fashion. Already Governor Park has begun instructing China on the virtues of exchange rate “flexibility.” One hopes he sees the virtue of flexibility as being universal in its advisability and not limited to China alone.
Ultimately, a concerted global effort will be necessary to address the global imbalances that have accumulated. Unwinding these imbalances will require the United States to rein in its fiscal policy, offsetting stimulus in the rest of the Organization for Economic Cooperation and Development, and adjustments in exchange rate policy in Asia. In the long run, either the Chinese yuan or an Asian regional currency will emerge as a reserve currency. Unless, of course, Korea’s plan to become a regional business hub also involves promoting the won as a key currency!
Unsettling U.S. financial markets, tutoring China on exchange rate policy, who needs the U.N. secretary-generalship when you have Governor Park bestriding the world stage? Indeed, Alan Greenspan’s term as chair of the Board of Governors of the U.S. Federal Reserve System will soon come to an end. Perhaps Governor Park would be interested.
* The writer is a senior fellow at the Institute for International Economics in Washington D.C.
by Marcus Noland